Considering that each American credit card holder has an average of 3.7 cards — according to the results of a recent Gallup survey— it’s safe to say that most people in the U.S. have a general understanding of how credit cards work.
Unfortunately, myths and misinformation about credit cards have made our knowledge a little hazy and cause us to make some serious mistakes when it comes to the plastic. If you recognize yourself making any of these credit card mistakes, it is best if you adjust how you’re using your credit cards.
1. Only making the minimum payment
It may seem that making the minimum payment is the easiest way to pay a credit card bill, however there are two major drawbacks to only paying the minimum each month. The biggest drawback is you’re paying more money over time in interest. Even by paying an additional $20 to $40 per month — which may not seem like a lot — you’re lowering the principal balance on the card, meaning that you’re paying less in interest.
The other drawback to only paying the minimum payment each month is that it may be negatively impacting your creditworthiness, or how financially sound you are in the eyes of a lender or bank. Because you’re only paying the minimum payment, you will have higher credit balances, which make lenders think that you may have taken on more debt than you can handle.
It’s essential to maintain your creditworthiness in case you intend on applying for a loan or credit card. In addition to paying more than the minimum payment, you should also make sure that you are paying your credit card on time because paying late could have a negative impact on your credit scores. Payment history makes up 35 percent of your credit score, according to FICO, so you could be lowering your credit score whenever you make a late payment.
2. Canceling old credit cards
It may seem like a smart financial decision to close out a credit card when you don’t need it anymore. You finally pay off one of your cards, so you close out the card to remove the temptation of falling back into debt. Although this seems like the best solution, you may be negatively impacting your credit scores.
Anytime you close out old credit cards, you are raising your credit utilization ratio, which compares the total used credit to total available credit to provide a percentage that directly impacts your credit scores and helps lenders determine how risky it is to loan you money. For example, if you have a total of $500 credit card debt and a total of $2,000 available credit, then your credit utilization ratio is 25 percent.
Most experts recommend that your credit utilization ratio falls between 10 and 30 percent. It directly correlates to your credit scores and only applies to revolving debt, such as credit cards, and not installment debt that has a fixed number of payments, such as a mortgage or auto loan.
3. Maxing out credit cards
We’ve all been in circumstances when we’ve needed to use a credit card to pay for an unexpected expense, and when you have no other option than to use a credit card, you’ll want to make sure you pay it off as quickly as you can. If you don’t pay down the balance quickly, you may be unintentionally lowering your credit score, considering that the amount you owe on your credit and loan accounts makes up 30 percent of your credit score, according to FICO.
On top of potentially lowering your credit score, maxing out your credit cards could also put you at risk of going over your credit card limit. When you’ve used up most of the available credit, any small charge, such as your interest or an unexpected automatic payment, could go through and put you over the limit, costing you more in interest and making it harder for you to pay off the card.
4. Applying for multiple credit cards at once
Opening new credit cards can raise your credit score since it adds to your overall available credit, thus lowering your credit utilization ratio.
On the other hand, applying for multiple credit cards at once has the adverse affect on your credit scores because you’ll have too many hard inquiries on your credit. Too many hard inquiries on your credit report can make it seem like you are taking on too much debt, which is a red flag for lenders.
What’s a hard inquiry? Anytime you apply to any type of loan, including a credit card, the lender pulls your credit reports to make sure you’re a good fit for the loan. These pulls of your credit reports are called hard inquiries, which also show up in the “credit inquiries” portion of your credit reports. Instead of risking the chance that you’ll get denied for a credit card, you’ll want to check your credit scores prior to applying, and then apply for a credit card that fits your credit score.
5. Neglecting monthly credit card statements
© 2014 American City Business Journals, Inc.