Are you new to credit cards? Do you want to understand how credit cards impact your credit history and how to maximize your credit scores?
Remember, a credit card can be a 100% free way to build up your credit, as long as you use it responsibly.
This is a guide to building and improving your credit with credit cards. You’ll learn:
- why good credit history is important
- how you can monitor your credit history
- how to pick your first card
- how your credit is affected simply by having credit cards
- the basics of how to use credit cards
- some easy tips for keeping your credit in great shape
Throughout the guide you’ll find links to pages and videos that dive deeper into specific topics. Follow all of those to get the most out of this guide. It’s a long guide, so you may want to take a break and come back later.
Once you’re done, I invite you to send me your specific questions and I’ll write right back to you. I want to know what you find confusing or want to know more about, and I always appreciate it when people drop a quick note just to tell me what particular sections they found most helpful.
Our goal is to help you develop good long-term habits, and an understanding about how to establish great credit history. Building great credit takes time.
This is not a guide about using risky techniques to try to manipulate credit scoring systems. Instead, we’ll help you understand the fundamental factors that impact credit scores so you’ll be able to make good decisions and build your scores responsibly.
You also won’t find information on this site about signing up for a card just to get a quick signup bonus and game rewards point systems. We want to give you the knowledge to choose to credit cards that will be a great fit for you for the long-term, or a card that is best for you wherever you are in the building process right now.
What are credit history, credit reports, and credit scores?
Your credit history is your past behavior as a borrower of money. Companies use this past behavior to determine how likely you are to pay money back, or more generally how trustworthy and reliable you are.
People with the best credit history (both in length of history and lack of negative items) are seen by lenders as very reliable borrowers, likely to pay the money back on time and in full.
People with bad credit history (late payments, maxed out cards, and other negative items) are seen as risky borrowers who may not pay the money back. Based on your credit history, a company may decide whether they want to do business with you, and on what terms.
To understand credit history, think of a trusted friend you have known for a long time. How comfortable would you feel loaning that person $300?
Now imagine you just met someone. Would you loan that person $300?
Since you’ve known your friend for a long time, you probably have a good idea of the likelihood of whether he or she will pay you back based on that person’s past behavior.
In the second situation you don’t know about any past behavior, so you probably wouldn’t want to loan the money at all. Or, maybe you would ask for an extra $50 for taking on that extra risk that the person might not pay you back since you don’t know much about his or her past behavior.
If you made that same $350 for $300 loan to 7 people, and only 6 of them paid you back, you wouldn’t lose any money. You loaned $2,100 and got back $2,100, even though one person did not pay you back.
Banks go through a similar process of measuring and adjusting terms for risk when they consider giving you a loan, but they use credit reports and credit scores to measure your past history to figure out the risk you might not pay them back.
When you apply for a credit card or a loan, a lender will check your credit reports and calculate credit scores to determine how likely you are to pay back a debt and decide whether to approve or deny you. If the lender decides to approve you, they’ll also use your credit history to decide the terms of your loan, like the interest rates or amount of the loan you should get.
Banks aren’t the only ones who use your credit reports to determine how risky you are to do business with, though. Here are several ways your credit history can impact you:
- Getting a Credit Card: If you have no credit or bad credit, you might not be able to get any credit cards. The worse your credit history is, the worse your credit card terms will likely be: you may only get approved for cards with low credit limits, high interest rates, and no rewards. On the other hand, with great credit history, you can get cards that offer the most rewards and best terms, like high credit limits.
- Getting a Mortgage or Auto Loan: This is another obvious one. With bad credit, you may not be able to get approved for a loan, or if you do, it will probably be at a much higher interest rates. While interest can easily be avoided completely on credit cards, the same is not true for installment loans like car loans. Interest adds up quickly on big-ticket items like cars and houses. Bad decisions that lead to bad credit history could cost you extra money for years if you have a high interest late on a long-term installment loan.
- Renting an Apartment: A landlord wants to know you’ll be able to pay your rent on time for the term of your lease, so your credit history provides valuable information about past behavior. If you don’t have credit history established, or even worse, have negative items like late payments on your credit reports, a landlord may decide not to rent to you. A landlord may ask for a co-signer, several months of rent up front, a higher security deposit, or some combination of those if you have limited or bad credit history.
- Connecting Utilities: When you’re renting an apartment and need to put utilities in your own name, you may run into trouble if you have limited or no credit history. Like any business, utility companies want to make sure they’ll be paid on time. If you don’t have credit history established, they may deny you service or require an additional deposit.
- Finding Insurance Coverage: While getting an insurance policy is not the same as getting a loan, there’s one major thing in common: another company is taking a financial risk on you. If you file many claims, possibly even fraudulent ones, the insurance company could lose money. They use your credit history, and other factors like driving records for car insurance, to determine how risky you are to insure. With bad credit history, you may be denied insurance coverage, or pay premiums much higher than someone with great credit.
- Cell Phone Plans: Most cell phone service providers require a credit check to open a new account, unless you’re getting prepaid service. Additionally, many smartphones are sold on financing plans now: you pay an installment for your phone as part of your bill each month instead of ~$800 up front. In order to get one of these financing plans, a credit check is necessary to make sure you’ll be able to pay off the entire phone. But remember, paying your cell phone bill on time does not help you build credit, even though not paying your bill can lead to negative items on your credit reports.
- Employment: In many states, employers are legally allowed to consider information on your credit reports when deciding whether to hire you. Negative items, like late payments, tax liens, and high credit utilization indicate financial irresponsibility, and could mean that someone can’t follow through with commitments, which are not traits of a good employee.
What is a credit report?
Credit history is recorded on credit reports. There are three major credit bureaus in the United States:
Each credit bureau collect and maintains data about your credit history in the form of a credit report. Your credit reports contain information about accounts you’ve had and your payment history. See our page about credit reports to learn more about the specific information and that’s included (and is not included) on credit reports.
What is a credit score?
A credit score is a number that indicates your risk as a borrower and the likelihood that you will pay your bills. Credit scores are determined by mathematical models based on information on credit reports
You do not just have one credit score. FICO is the most commonly used brand of score in the U.S. and VantageScore is another brand of score that’s gaining popularity. Under each brand there are multiple credit scoring models, and since there are three different credit bureaus each type of credit score could be calculated based on any one of your three credit reports.
It may be tempting to watch your credit scores closely and obsess over every point, but that may not be the best use of your time and energy. Credit scoring models are proprietary, so it’s impossible to know exactly why one of your credit scores has gone up or down by a few points.
Instead, focus on the fundamentals of building good credit history. This includes:
- paying all your bills on time
- keeping your utilization low
- leaving accounts open for a long time (closing an account is not necessarily a good thing)
As long as you focus on the fundamentals to build good credit history on your credit reports and you’ve made sure there are no mistakes on your credit reports, all your credit scores should reflect your good behavior eventually. Remember that lending decisions are not made entirely based on one of your credit scores, but also based on other information you submit on a credit application, like your annual income.
Now that we’ve discussed how your credit history is measured, let’s move on to some ways can monitor your credit.
Getting Started: How’s your credit history?
If you don’t know how to check your credit reports, that’s a good place to start. Errors on credit reports happen, so you’ll want to check all your reports at least once per year to correct any inaccurate information.
You can access your credit reports in a few different ways. You are legally entitled to one free credit report per year from each credit bureau at www.annualcreditreport.com. Learn more on our page about monitoring your credit reports, including other places you can see your credit reports.
Because you have so many credit scores, checking and monitoring them can be a little trickier. However, it can be nice to follow some of your credit scores over time to get a general idea of how good or bad the information on your credit reports looks to lenders. Since you have so many credit scores and generally won’t know what credit score a lender is seeing, it’s futile to worry when the scores you’re monitoring going up or down a little over time.
First, you can start by learning a bit about the factors that major credit scoring models consider and how they weigh those factors when they calculate your scores. Once you understand this, you’ll have a better idea of whether a particular action might look good or bad to lenders.
What’s In Your Credit Score?
This chart shows the criteria used to create FICO scores and their relative importance in your credit score.
Since lenders tend to use one of the FICO scores, many people want to monitor those. Most major credit card issuers have started offering a FICO score for free at least once per month. See an up to date list of places to get some of your credit scores here: How Can I Get a Free FICO Score?
Although VantageScores are different from FICO scores, many of the same factors are considered and weighed similarly. There are several free services, like Credit Karma, that will let you monitor some of your VantageScores on a regular basis. This can be useful to give you a good estimate of whether you look good or bad to lenders, and if you’re looking better or worse over time.
If you have fair or bad credit (a FICO Score of less than 700 or so), you’ll be able to benefit quite a bit by using the principles described below because you have a lot of ground to cover.
If your credit is already good or excellent (a FICO Score of about 700 or higher), you’ll see less of an improvement because you don’t have as far to go, and you’re probably already aware of some or all of this information.
Why Credit Cards?
There are certainly other ways to build credit, and you can build credit without a credit card, but credit cards have many advantages beyond just building credit. Also, they can be a convenient and easy way to add more accounts to your credit history even if you already have other types of accounts, like installment loans.
Here are some benefits of credit cards to consider:
- Many credit cards don’t have annual fees, which means they can be free to have
- Interest can be avoided as long as you don’t revolve a balance from one month to the next (carry a balance is not required to build credit!)
- Responsible credit card use will improve your credit report and credit scores over time
- Credit cards provide great buying capacity – how else could you safely carry around $10,000 of purchasing power?
- If you lose your credit card you can simply cancel it and call for a free replacement, which isn’t something you can do with cash
- You are not held liable for fraudulent credit card use, so you don’t need to worry about theft as long as you report your card as lost or stolen immediately
- Many credit cards offer rewards in the form of points or cash back, which can add up to significant savings over time or give you other perks like free flights
- Additional online rewards portals offered by some card issuers, like Discover Deals or Chase Ultimate Rewards, where you can find significant discounts at popular retailers
- Credit cards usually provide purchase protection, covering items you buy against damage and theft for a few months, as well as extended warranties and insurance for travel and auto rentals
Using Credit Cards to Build Credit
Credit cards will affect your credit in several different ways, and that process begins as soon as you apply for one (even if you’re denied). The main principle is to use your cards responsibly by always paying your bills on time, but there’s more to it than that.
Let’s start at the beginning with a credit card application, and move on to how using them will affect your credit. For each aspect, we’ll point out whether it has a positive, negative, or neutral effect on your FICO credit scores.
Choosing Your First Credit Card
If you don’t already have a credit card, you may not have any credit history established yet. Checking your credit reports and scores in the previous step should give you a decent idea of where you currently stand credit-wise.
This section is about understanding your options for getting a first card, so this step doesn’t have any direct impact on your credit until you decide to actually apply for a card in the next step.
The right first card for you should fit into your purchasing habits and lifestyle. You shouldn’t need to go out of your way to use it. If you already use a debit card to buy things, you could start by making those purchases on a credit card instead.
In general, the better your credit is, the more (and better) options you will have when choosing a card. This means as you build your credit you could be able to qualify for cards that earn more rewards and provide more benefits (like airport lounge access, for example). As you understand credit cards more, you can develop a strategy with multiple credit cards to maximize your benefits and rewards.
Most major banks report credit card account activity to all three major credit bureaus, which is necessary for you to build credit history. Banks are not required to report to the credit bureaus, it’s actually voluntary, but most of them do anyway.
Let’s take a look at some of your options for your first credit card:
Apply for a Specific Card
However, this approach can be overwhelming since there are so many credit cards out there. If you don’t already have much credit established or don’t have a card in mind that you want to get, this option is probably not for you.
Check for Pre-Qualified Offers
You may have received an offer in the mail that says you’re “pre-approved” or “pre-qualified” for a certain card. In many cases, a credit card issuer has already screened one of your credit reports and determined you’re a good fit for one of their cards.
While you’re not guaranteed to be approved for one of these pre-screened card offers, you may be more likely to get approved since the issuer has already checked your credit history to some degree. Many major credit card issuers allow you to check for cards that will be a good fit for you on their websites, and sometimes you’ll get better rewards other terms than someone who applies without being pre-screened.
Become an Authorized User
This can be a shortcut to establishing some credit history.
If you know someone with good credit who trusts you (and whom you trust), you could ask that person to add you as an authorized user on his or her credit card account. Most credit card issuers will start reporting the activity of this account on the authorized user’s credit reports.
One benefit becoming an authorized user is that it doesn’t require a credit check. This means even if you have no credit or bad credit, you’ll be able to get a card and start using it to build your credit without applying.
The downside of this approach is that delinquencies from the primary cardholder, like late payments, will also show up on the authorized user’s credit reports. This is why it’s important to only become an authorized user on the credit card of someone you trust and who you expect to be financially responsible for years to come.
Student Credit Cards
If you’re a college student, there are special credit cards designed to help you start establishing credit history.
Issuers don’t expect applicants for these cards to have significant credit history already. Learn more about student credit cards here.
Secured Credit Cards
If you have bad credit or no credit, banks may think you’re too risky for them to issue you a regular credit card. Instead, you may be able to get a secured card.
If you get a secured card, you need to make a deposit to establish your credit limit. For example, if you apply for a secured card and deposit $200, you would end up with a credit limit of around $200.
If you don’t pay your bill, the bank keeps this deposit. Banks do this since people with bad credit are more likely to not pay their bills.
A secured card is meant to be a starting point for building or re-building credit so you can eventually qualify for other “regular” (or unsecured) credit cards. Once you’ve used a secured card for its purpose of building credit you can get your deposit back by closing the card. Some issuers will let you convert the account to an unsecured card product instead. To learn more about the impact of closing or converting a secured card, watch this video.
Regional Banks or Credit Unions
If you already have a banking relationship established with a local bank or credit union, you may be able to get a credit card from them. Even if you have no credit history or limited credit history established, they may willing to extend you credit since you already have an existing relationship.
If you decide to get a credit card from a small regional bank or credit union, ask them whether they report to all three credit bureaus first. That way you’ll know your responsible credit use will be rewarded by establishing credit history on all three of your credit reports.
Store Credit Cards
You’ve probably been asked if you want to apply for a store credit card when you’re making a purchase, whether it was at a checkout line or you were buying something online.
Store credit cards are generally not as good as regular cards from big banks. They tend to have worse terms, like lower credit limits, than general-use credit cards. Also, many store credit cards can only be used at certain stores instead of anywhere major credit cards are accepted.
Sometimes these store cards will come with incentives, like a discount on your first purchase. Store-branded credit cards are often marketed aggressively, and as a result many people who don’t understand how credit works end up in debt or damage their credit history.
Watch this video to learn more about the disadvantages of store cards.
Store credit cards can be a good idea if you fully understand the terms of the card and shop at a certain brand of stores enough to take advantage of the rewards and benefits provided by the card. Just make sure you understand the role they play in your overall credit card and credit-building strategy.
One upside of store credit cards is that they tend to have lower approval requirements than cards from big banks. This means you might even be able to get a store credit card if you have little or no credit history established. If you have weighed the other options for your first card and think you can benefit from a store card as a starting point for your credit-building journey, it could be a decent option.
Applying for a Credit Card
Now that we’ve reviewed some of your options for your first card, you may be ready to apply for a credit card.
Usually, applying for a credit card involves filling out a form online. You may find out if you’re approved within seconds of submitting the application. Other times, you may need to wait for the credit card issuer to manually review your application and make a decision. If you don’t receive an answer immediately, the issuer will mail you an answer within about 7-10 days.
Sometimes an issuer will ask for additional information after you’ve submitted the application. For example, credit card applications ask for your annual income, and the credit card company may ask for documents for you to verify your income to make sure you didn’t just make up a number.
When you apply for a credit card, the issuer will check one or more of your credit reports to decide whether you should be approved.
Any time you apply for new credit and the lender checks your credit reports, it is called a “hard inquiry.” A record of this hard inquiry will be included on your credit report for two years, and it will be factored into credit scores for one year. The hard inquiry stays on your credit report whether you’re approved or denied, but does not contain information about whether you were approved.
A hard inquiry will generally have a slightly negative effect on your credit scores, even though it’s a normal part of the credit application process. This is because it shows that you’re actively seeking credit.
A few hard inquiries over the course of the past two years is not really a big deal, but many hard inquiries in a short period of time can indicate that a you need a loan because you’re in a tight financial situation. Frequent hard inquiries, like submitting 10 credit card applications over a 6 month period, may mean that you are a riskier borrower. As a result, your credit scores will likely go down to reflect that if you have a high number of inquiries, and it can become more difficult for you to get approved for new credit. See this video to learn more about hard inquiries, and how many is too many.
Getting Approved for a New Credit Card
If your application for a credit card is approved, the account will now be open. That’s why it’s important to really consider whether you want a card before you apply.
Some people get to this stage and feel buyer’s remorse. This might happen if you feel like you were talked into a store card at the checkout line, but then realize the card isn’t actually something you want. You may think that if you don’t activate the card, the account will not be open and will not impact your credit, but this is false.
Once you’re approved for a credit card, it will affect your credit in several different ways, some positive and some negative. But remember, if you’re denied, nothing else will happen — there is no negative consequence other than the hard inquiry on your report.
So, let’s look at the ways your credit scores are impacted by a new credit card account.
New Credit (10% of a FICO score)
Opening many new accounts in a short period of time is seen as risky financial behavior, because it looks like you’re in need of money and are acting recklessly. This “new credit” factor considered in your credit scores is where the number of inquiries and length of time since your most recent inquiry come into play. The length of time since you last opened an account can also be factored in here.
This increased risk of having new credit will have a small negative effect on your credit scores.
Luckily this category only accounts for 10% of your total FICO score, and you can reduce the impact by not opening a lot of new accounts quickly. The only other way to improve the points earned from this category is to wait until your account is no longer considered to be “new” and hard inquiries have aged over one year.
Length of Credit History (15% of a FICO score)
The longer your credit history, the better. If you established accounts a long time ago and have been able to manage them responsibly, that demonstrates to lenders that you’re less risky than someone who doesn’t have a very long credit history.
If you take the length of time each of your accounts has been open and average them together, that’s the average length of your credit history. This average is considered in credit scores because you’re seen as less risky to lenders the longer your accounts have been open. The ages of your newest and oldest accounts are also considered.
When you open a new credit card and already have some older credit cards, you’ll reduce the average age of your accounts, and this will have a negative effect on your scores.
If the average age of your accounts is less than about six or seven years, your credit report is considered to be “short” and you won’t get the maximum points from this category. This isn’t usually a very big deal because this category only accounts for 15% of FICO scores, so you can still have good credit even if your credit history is short.
The only way to improve here is to wait for accounts to age and be careful about adding new credit accounts, because every time you do you’ll reduce the average age of your accounts.
Diversity of Accounts (10% of a FICO score)
The more diverse your credit report, the better.
Credit cards are known as “revolving debt,” while personal loans, auto loans, and others are known as “installment debt.” The main difference is that your balance and payments can go up or down every month with credit cards, but the terms of installment loans are fixed at the outset. Being able to manage multiple types of loans, and more accounts, generally shows lenders that someone is less of a risk.
So, adding a new credit card with revolving debt could increase the diversity on your report and number of accounts, resulting in a small positive effect on your credit scores. This is a small category, only contributing 10% of your FICO credit scores, so it’s probably not a good idea to open new accounts simply to increase your account diversity.
If you only had installment debt on your report previously, with no revolving debt, this will make a relatively big impact. But if your credit report is already very diverse and you have a credit card, adding another credit card account will have little or no effect here.
Amounts Owed (30% of a FICO score)
When you open a new credit card account, you’ll be assigned a credit limit. The credit limit is the maximum amount you can spend on the card at any one time before you need to pay some of it back to the credit card company.
The percentage of the credit limit you use on each credit card and across all credit cards is a major factor in credit scoring models.
Even if you don’t use the card you just opened, the credit limit will show up on your credit reports with the account and will be factored into your credit scores. This additional available credit could have a significant positive impact on your credit scores, depending on the balances and credit limits of your other credit card accounts.
This factor really depends on how you use your cards, so it’s covered extensively later, and we’ll come back to how opening a new card can help this factor.
Before we come back to credit limits and how you spend on a card, let’s pause for a second to talk about an important part of having a credit card: paying your bill.
Your Payment History (35% of a FICO score)
The biggest factor in your credit scores is whether you pay your bills on time.
Credit scores are designed to help lenders determine how likely you are to pay your bills. If you have a history of late payments, accounts going to collections, or similar items on your credit reports, that’s a strong indicator that you’re a risky applicant.
Most delinquencies, like late payments, will remain on your credit reports for 7 years!
A history of late payments and other delinquent behavior will have a strong negative effect on your credit scores for many years.
Many types of accounts are considered here, from credit cards to mortgages to student loans. Your payment history for all of them will be considered, and factors like how late the payment was, how much was owed, and how recently it occurred will all come into play.
If accounts become very late they can be sold to collection agencies, becoming collection accounts. These will have a strong negative effect on your credit scores. The newer they are and the larger the debts, the worse the impact may be.
The most important thing you can do to build and maintain good credit history is to pay all your bills on time. Set up automatic payments to always pay at least the minimum required amount each month. Or, better yet, set up automatic payments to pay the full new statement balance each month so you’ll stay out of credit card debt and avoid interest completely with most cards.
Paying your credit card bill sounds straightforward, but we’ve come this far and still haven’t even talked about what an APR is or what “minimum payment” means. For a detailed look at the process of paying a credit card and an explanation of the relevant terms, read this guide to how paying a credit card works, then come back here to continue.
Your Balances and Credit Limits (30% of a FICO score)
Now you have a new credit card and you’re starting to buy things with it.
Any amount you spend on the card will be added to the balance, which is the amount you owe to the credit card company. A balance could also be called “credit card debt.”
The balance and credit limit of each of your credit cards is very important for calculating your credit scores, and could have either very positive or very negative impact.
There is a factor that accounts for 30% of the points in FICO credit scores called “Amounts Owed.” It considers things like:
- how many accounts have balances
- the balance on each account compared to the credit limit of that account
- the total balances across all accounts compared to the total credit limit across all accounts
Credit scoring models look how much of your available credit you’re using on each card and across all cards. They do this by calculating the percentage of your credit limit you’re using.
This percentage is called “credit utilization” or more specifically “revolving utilization,” since we’re only talking about credit card accounts here. Using a high percentage of your available credit is seen as very risky, since it may indicate that you’re overextended financially and may have trouble paying your bills as a result.
This factor is why maxing out credit cards causes credit scores to drop dramatically.
To figure out your overall credit utilization, simply add up the credit limits on all of your credit cards. Then add up the balances on all of those cards. The percentage of the total balance compared to the total credit limit is your revolving utilization.
For example, say you have two credit cards, and each one has $5,000 credit limit. You have a balance of $2,500 on one of the cards, and $500 on the other. When you add each of those up, your total credit limit is $10,000, and your total balance is $3,000.
Now, we divide $3,000 by $10,000 and get .3, or 30%. That’s your revolving utilization, and it means you’re using currently using 30% of the revolving credit available to you.
Generally, the lower your credit utilization, the better it is for your score. One exception is that 0% utilization can technically result in lower credit scores that 1% utilization, but that basically only happens if you are really trying to have 0% utilization and shouldn’t normally result in a much lower score. People with excellent credit scores tend to have a utilization around 7%.
Let’s go back to how opening a new card can impact your utilization percentage…
If, for example, you have only one credit card that has a $1000 credit limit and a $900 balance, you’re at 90% utilization. This would have a significant negative impact on your credit scores.
Now, if you open a new card that has a $1000 limit, your new total limit is $2000 with the same $900 balance, reducing your utilization to 45%. That’s still a relatively high utilization percentage, but 45% looks much better to credit scoring models than 90%. So, opening a new card or increasing the credit limits of cards you already have could have a potentially large positive impact on your credit scores.
Credit scoring systems also look at the number of accounts that have balances at all: a large number indicates higher risk, and that has a negative effect on your scores.
Installment loans are also included here: scoring systems check for how much of the original loan still needs to be paid off. The more of the loan that’s been paid off, the better.
Simply put, the lower your balances relative to your limits, the better your scores will be.
Putting It All Together
This may seem like a lot of information, but it all boils down to some fairly simple principles. When you consider all the various effects we’ve talked about, you can come away with these solid tips for building your credit with credit cards:
Tip 1: Always Pay Your Bills on Time
- Late payments and similar delinquencies have a long-lasting negative impact on your credit scores
- Set up automatic payments to avoid being late
Tip 2: Keep Your Utilization Low
- Maintain low balances across all of your cards as close to 1% as possible
Tip 3: Don’t Apply for Too Many Cards in a Short Period of Time
- Many hard inquiries can have a negative effect on your credit scores
- If you’re approved for new accounts that will lower the average age of your accounts, which has a negative effect on credit scores
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