W.I.C.A? Pt 3: How to manage your credit
Back in Part 1, I compared using credit to playing with fire. You shouldn’t play with fire. You should understand fire, respect fire, know how to safely use fire, and how to put it out. Like wise I recommend you take a similar approach to credit.
In the Beginning…
In this section I am going to assume you are just beginning your credit journey. As I mentioned in Part 2 everyone comes in to this world naked — that is, no credit score or history.
If you are under 18 you cannot legally enter a contract… though that doesn’t entirely mean you can’t start using credit. I’ll touch on this further in a separate blog.
Anyways at this larval phase, you won’t have many good credit options due to your lack of credit history and low credit rating. You are weak and easy prey to predatory lenders looking to get you into extremely high interest contracts known as sub-prime credit. Give them the chance and they will rip you apart. Stay patient, lay low and you will survive to emerge as a graceful butterfly — with excellent credit of course.
There’s a number of ways to do this. If you are a college student you may find credit building options from your local bank. I started out with the Wells Fargo Cash Back College Card. I believe these banks, seeing that your are in college, and oh so full of future earning potential, want to win your loyalty early and therefore offer you credit options at a Prime interest rate (as opposed to Sub-Prime I mentioned earlier).
Another option, especially if you are not in or out of college is to get a secured card. You see having no record of trustworthiness to go on, banks typically need some kind of insurance from you just in case you turn out to be a deadbeat. For this they created the Secured Credit Card. In this kind of credit agreement, you put money down to “secure” your credit.
For example if you get a credit card with a $200 limit you typically will give the bank $200 in exchange to secure the loan. This does not mean you’ve paid $200 for a credit card, this only means that if you turn out to be untrustworthy and don’t make your payments (which I’m sure you won’t since you are reading this) the bank can then cover themselves by taking that $200 you deposited. After establishing a secured credit line and using it responsibly (as I will explain in the next section) for about 6 months, you will be able to convert your account into a unsecured credit. As a congratulatory gift for graduating to grown-up credit the bank will return your deposit. This allows you to start establishing your credit without having to pay sub-prime interest rates since you secure your loan. Secured cards can be an excellent way to begin to repair your credit too if you are reading this too late.
Now the options above assume you are working and have a steady income. I would highly recommend you have a steady income before really getting involved in the credit world. However, I’m not saying you can’t get the ball rolling at least. If you have parents who are well trained in the art of credit, ask them to be added as an authorized user on their credit cards. This way you will start building credit history as long as your parents exhibit responsible credit use. Ensure the credit issuer actually reports authorized user activity to the credit bureaus though — major key.
There are other options for starting out you may want to know about… but I’ll just cover my favorite here.
The K.I.S.S strategy
Okay now lets get to the real talk. Now you’ve got that credit, lets learn to use it. I am going to discuss a strategy I decided to just now call the K.I.S.S strategy — yes, you guessed it… the Keep It Simple STUPID! strategy.
Seriously managing your credit is NOT hard so don’t make it hard. All you have to do is abide by a few simple guidelines.
First, get your mind right, remember credit cards are for building trust. They don’t represent extra money. Don’t even think of them as money to use in an emergency (yeah I said it). Use your credit card for everything — that is everything you would normally purchase if you didn’t have the credit card.
If you know you would not afford an item if you only had your debit card or cash then don’t buy it with your credit card.
It’s really that simple keep your normal reasonable budget, except instead of using your debit card or cash use your credit card to cover the purchase instead.
Consider the money you spent on your credit card the same as you paying cash — after all you do have to pay it all back in the end. So don’t go spending that money in your account like its still yours. At the end of the month cover what you spent on your credit card with that cash.
By doing this you have demonstrated you can borrow and payback money responsibly. You are showing yourself to be trustworthy, the banking overlords are pleased.
WAIT, okay its not that simple. One of the biggest statistics that influences your credit score is your utilization. That is how much of your credit limit you are using. If you have a $500 credit card, please please don’t use the whole $500. Well if you pay it off in full before your credit statement posts you should be fine… but no forget you read that. What we want to do here is establish winning credit management habits and the biggest one of all is to keep your utilization low!
Those with credit scores at the higher end of the spectrum keep their utilization below 10%. Of course this is hard to do when you are starting out as that would mean you could only spend $50 on your $500 limit card. Give yourself some leeway to start aim for utilization below 30%. So with your $500 limit card set your spending limit at $150. Never ever leave a balance on your card above 30% of your total limit.
Okay so yeah, Keep it pretty simple STUPID!
Pay your balance off in full EVERY MONTH — or don’t…
Leaving a balance on your card, especially one that exceeds how much actual cash you posses, is EXACTLY what I was talking about when I said using credit is like playing with fire. Again this is due to interest working against you. In addition, if you leave a balance at the end of the month you may get into a situation where you keep spending and leaving more and more on the card every month until you run a debt that you cannot manage. Trust me I’ve been there — when I didn’t know better of course.
However, I think leaving a small balance on your card is not necessarily a bad thing, especially when you start getting higher limit cards. When your credit card lender reports on your trustworthiness there are two data points that are especially important.
- Whether or not you made your minimum payment
- You card utilization percentage
Both are important but missing a payment is definitely much more damaging and harder to recover from. In this context of how to manage your credit card balances though, the utilization percentage is what is in play here. I mentioned earlier that the highest credit scores are owned by credit users with less than 10% utilization. However as an interest plot twist those with utilization at 0% have tend to have low credit scores.
This seems to say that you should leave at least a small balance on your account — less than 30% of your credit limit is recommended, less than 10% is preferred. The downside to this is that you will pay interest on the balance that you leave on your card. The good news is that if you keep your utilization very low, the interest charge should be quite negligible. The better news is that there is a strategy if you want to avoid paying interest at all…
If you want to avoid paying interest but still get the benefit of having a utilization above 1% what you need to do is pay the balance in full after your statement posts. So before you minimum balance is due pay off your account in full. This way your bank reports a balance on your statement which gets reported as utilization but your balance is paid off before your credit lender has a chance to charge you interest (Interest accrues on the balance left after the minimum payment due date). To use this strategy effectively be sure you still adhere to the iron rule of never spending more than 30% of your credit limit on your credit card. If you post a statement with a high balance it is going to hurt you even if you pay off your account before your minimum payment due date.
After learning the basics of the game… now get on offense.
Okay now you’ve got the basics of the game. Obtaining a good credit score is really not rocket science as I’ve shown. So now its time to get fancy. Earlier I advocated for using your credit for all your normal, in-budget, purchases. The reason my advice is different from your dad’s who I’m sure has told you to use your credit card sparingly is due to… The Rewards!
Yes you’ve probably heard of it before, some credit companies will give you different kinds of perks for using credit for your purchases. The more often you use your card the more they give you. Now if you’re a credit youngin’ you most likely won’t qualify for these kinds of credit cards quite yet. But I want you to get used to and comfortable with using your credit card for everyday purchases and of course — responsibly paying it off. When you finally can qualify for some of the best rewards cards you will already know the drill.
There is a whole buffet of different types of rewards you can get depending on the credit card. Cash back on purchases, hotel discounts, flight discounts, and luxury gifts are a few of the popular ones just to name a few. If you are a travel addict like me, having a stellar travel rewards card is a simply a must do.
This is pretty much the pinnacle of the credit card game. Once you start getting rewards for being financially responsible you are now playing with the pros. But don’t get too cocky, stick the the basics because there is still lots of trouble you can get into — this is interest we are talking about here… its literally fire… respect it. This is especially true when evaluating rewards cards offers, there are a lot of them out there and they are NOT all created equal. I like to crowd source my rewards cards knowledge so I usually visit the r/churn subreddit to see what the rewards card aficionados are raving about lately. They have an excellent resource where rewards offers are evaluated by a body of your peers!
Ironically, in the LAST AND FINAL installment of W.I.C.A… we will learn all about the ways you can get burned.
Join us for the next episode: What Affects my Credit…Anyways?
The TL;DR (Too Long; Didn’t Read)
- When you start building your credit, you won’t have many attractive credit options
- Credit youngin’s can begin building credit using special Student Credit Cards, Secured Cards, or sub-prime retail cards (avoid this option).
- Keep your credit management strategy stupid simple! Use your credit card for normal every day purchases and pay your balance off every month.
- Never use more than 30% of your credit limit on your credit card.
- For the optimal score make your credit lender reports a small balance on your credit statement, to avoid paying interest on the balance pay off your account in full before your minimum payment is due.
- Once you get your credit score high enough to qualify for good rewards cards, you can get on the credit offensive and start getting benefits for your trustworthy credit behavior.
- In the next episode, we’ll cover… What Affects my Credit Score Anyways?
