A credit card is a great way to build credit, but it can be very risky when misused, costing you a lot of money and damaging your credit score.
A credit card is a great way to earn rewards, enjoy perks and build credit, but it can also be very risky when misused. If you carry a balance and don’t pay it off in full and on time each month, you can end up with a late fee, penalties and high interest rate charges. In this article, we’ll break down 10 common mistakes and how to avoid them.
Responsible credit card use takes a little discipline and self-control. But most of the mistakes here have easy remedies, good habits you can pick up with some mindful practice.
1. Making only minimum payments
Paying only the minimum amount due each month just keeps your account in good standing and helps you avoid late fees and penalties. However, if you’re making only the minimum payment on a monthly basis, it can take a long time to pay off your credit card debt as you’ll have to pay interest charges. Not paying the full amount due can also add months to the time it takes to pay off debt.
Before you start taking on more expenses, establish a payment plan that will help you manage your finances and make consistent on-time payments.
2. Carrying a balance
Carrying a balance month-to-month increases your debt but it can also hurt your credit score. When you carry a balance, your credit utilization ratio will increase, which is the amount of debt you have compared to your available credit. That’s a major factor credit bureaus use to determine your credit score.
According to a study conducted by FICO, high performing consumers with an average credit score of 800 use less than 7% of their credit limit.
Carrying a balance can also be risky, especially if you’re dealing with high interest rates. Although a cash back card sounds like a great way to earn money off your purchases, all that savings is of no value if you’re paying high interest.
Credit cards are so easy to use, a lot of people tend to overspend on their cards, especially with online shopping. When we don’t pull cash from our wallets, it’s hard to understand or remember where it all goes.
Two good practices to follow: keep your credit utilization ratio under 30%, and only use a credit card for purchases within your monthly budget that you know you can pay off before the end of your billing cycle. Your credit utilization accounts to 30% on your credit score!
4. Missing a payment
Late payments or missed payments can ding your credit score significantly if you’re 30 days past due. According to FICO, if you’ve missed a payment for a 30 day period, you can expect to see a 17 to 83 point drop on your score. And, if you missed payments for 90 days, you can see a 27 to 133 drop on your score.
Autopay is a great way to ensure that payments are made on time. If you wish to pay it on your own, consider setting up reminders or alerts two to three days before your due dates.
5. Failing to review your billing statements
It’s important to make sure that the transactions on your billing cycle are correct. Doing so will allow you to take quick action against fraudulent transactions.
It’s a good idea to review your statements every week to make sure all the transactions are accurate. The sooner you report fraudulent activity, the sooner your card issuer can repair your credit history.
6. Taking cash advances
A cash advance is one of the most expensive things you can do with your credit cards. Unlike regular purchases, cash advances don’t have a grace period, and interest will start to accrue immediately on the money you withdraw. In addition to the high interest rate, you’ll also likely incur a fee of around 5% of the advanced amount.
7. Maxing out your cards
Never max out your available credit. Doing so will negatively affect your credit score and increase your credit utilization ratio, which can lead to higher interest rates and lower credit scores.
Here’s an exception: use your card for a big purchase but pay it off in full as soon as possible, within the same billing period. It won’t impact your utilization ratio and you can still reap the card’s rewards and perks, without paying interest on a carried balance.
8. Ignoring the terms and agreements on your cards
Going through credit card agreements is a lot of work. There’s a lot of fine print that can be confusing. But it can help you understand how your credit works (especially your interest rates) and how to use it well. Your agreement details penalties, fees and interest rates associated with the card.
A good understanding of your card’s terms and conditions can help you avoid hidden fees and unexpected surprises.
9. Opening too many credit cards within a short period
Every time you apply for a new credit card, there will be a hard inquiry on your credit report. This can increase the risk of rejection on future applications. The more hard inquiries you have in a short period, the riskier you will appear to lenders, too.
Ideally, try to only apply for a credit card once every six months. That’s a timeline most card issuers see as reasonable, and if you’re accepted, make sure to avoid the mistakes listed here.
10. Closing your credit cards
The length of your credit – how long you’ve held open cards – is part of your credit score. The average length of time that you’ve had credit cards accounts to 10% of your credit score. Each time you close a credit card account your credit score is impacted.
Although it’s generally not recommended to close a credit card, there are times when it’s beneficial to do so. For instance, if a card has a high annual fee but offers limited benefits, then it’s time to weigh the pros and cons of closing it.
What are the consequences of a credit card default?
With a postgraduate degree in commerce from The University of Sydney, Pranay has his finger on the pulse of the finance industry. Breaking down complex financial concepts is his forte.