Venturing into the world of credit cards can be both exciting and scary. Your first credit card starts your financial journey, including contributing to your credit score (also called "FICO score"). This is the best time to learn what not to do with your newfound access to credit.
Let us empower you with the credit card knowledge you need to avoid these five rookie mistakes. If successful, you will be well on your way to credit card stardom. However, falling into these traps early on can take years to correct, causing you to be potentially denied future credit offers, mortgages or auto loans.
1. Paying the Minimum
You received your new card and all is going well; however, you have run the card up to the limit. Whoops! Maxing out your credit card can affect your credit score, but the bigger mistake would be to pay the minimum payment.
Minimum payments are designed to be an attractive number that only pays a small percentage of the balance of your credit card. By paying the minimum, you are extending the time in which that balance will remain on the card, and you will accumulate a lot of extra debt in the form of interest. This means that it could take many years of paying the minimum to pay off the card, assuming you don't use it again; likely up to 10 years.
The better way to approach paying your credit card (if you cannot pay it off in full each month) is to pay at least 10-20% of the total balance each month. This will give you more room from the credit limit and prove to creditors that you are managing your credit effectively. Doing this will pay down your balance in less than three years. The best way to avoid extra interest is to pay your balance in full each month.
2. Too Many Credit Cards
Once you have established your credit, and paid on time for awhile, you will see more credit card offers rolling into your mailbox. There is a huge temptation to take these offers and continue building your credit.
However, the more credit cards you add, the bigger the potential negative impact to your credit score. While you may be approved for these cards, FICO scores take into account your credit to income ratio. In other words, the amount of money you earn (from your job) versus the amount of credit you have. This ratio will contribute to how your score is calculated.
Only apply for cards that you need and minimize the total amount of credit cards you use. A good rule of thumb is building a relationship with 2-3 credit cards and keeping these relationships long term.
3. Canceling Credit Cards
As we stated in the last point, you want to keep long term relationships with your credit cards. Another factor that contributes to your overall credit score is the age of your accounts (how long you have had your credit card.)
Someone with a shorter history of credit cards and many new accounts is viewed as more of a risk. Keep the first card you ever received and use it at least once in a while. This will show a longer credit history and keep the account active.
Better offers will come along, but don't be tempted to cancel the card(s) you already have in your wallet. It is possible to negotiate new rates, or in some cases, get points or miles added to an existing card. The benefit of keeping the credit card active long term is a healthy credit score.
4. High Rate Cards
The first credit cards you will likely be approved for are naturally going to have a higher interest rate since you are a credit newbie. You have not proven yourself just yet and the credit card company places a higher rate for those with a perceived higher risk of not paying.
It is okay to have and use these cards early on in your consumer life; but the higher the rate, the higher the payment as your balance grows. There are ways to avoid these higher interest rates going forward.
As you build a payment history with this first card and keep your balance around 30% or less, you will start to see the limit of the card increase from the bank. That does not mean that you should increase your spending, but it does mean that the credit card issuer is more trusting of you.
This will provide you an opportunity to negotiate the rate of this card. Credit card companies want to keep you as a customer and will lower your rate a bit if ask them to do so.
5. Late Payments
One of the biggest mistakes you can make when it comes to your credit history is to be late or miss payments. Your credit score is your "report card" on how well you pay your bills. Paying late instantly tells them that you are not reliable. Consistently fall behind and it will severely impact your credit score.
The easiest way to avoid missing a payment or being late is to use the auto pay feature to make your payment automatically. You can do this through your bank's online bill pay, or you can add your bank account information directly to your credit card account. Either way, you won't worry about missing a payment.
Another great tip, if you are not comfortable with auto pay, is to set a calendar reminder at least a week before the due date. If you are new to credit cards, it will help you to get into a routine of checking your statement as soon as it is available and then setting this reminder.
Do not fall behind; it is much tougher to catch up if you do. If you are late or miss a payment, that will lead to late payment fees and more accrued interest.
Make paying on time or early a priority, then turn it into a habit.
The society we live in relies on credit scores to determine if consumers are capable of repaying a loan. Credit cards are a great way to build your credit score, but you must avoid the biggest mistakes of credit card use:
- By paying more than the minimum, you avoid making your credit obligation deeper than you can handle.
- Avoid taking on more credit than you can handle.
- Keep your lines of credit open for as long as possible to build your credit history.
- Don't settle for high rate cards, by following our tips, you won't have to.
- Pay your credit cards on time, every time.
- You may be new to the world of credit cards, but hopefully, we have taken some of the mystery out of the mistakes that should be avoided.
- Treat your credit cards as a tool, and continue using them wisely.
Above all, do not sweat it. There are many credit card newbies like you out there and many great cards and resources to help you build your credit score and find your way to financial success.