The 6 Best Practices to Use a Credit Card Responsibly

Before discussing how to use a credit card, it is important to understand the point of credit cards. Credit cards are a safe, convenient form of payment that also incentivize you to use them by offering rewards such as travel points or cash back. Although these benefits of credit cards, they should not be the main reason that you use one.

The main reason or point of using a credit card is to build your credit score so that you have access to capital. What does this mean exactly? Your credit score is used by lenders to determine the likelihood that you will pay them back.

A higher credit score makes you more attractive to lenders than a lower credit score. When you understand how to use a credit card, you can get access to better interest rates which can be very beneficial under certain circumstances.

You have likely heard that borrowing money under any circumstance is a stupid decision. However, this is simply not true. At times it can make sense financially to borrow money, such as when financing a car will earn you more money than paying cash for a car.

By using a credit card responsibly, you are able to improve your financial life as it will give you access to capital when you need it. Keep in mind that credit cards can get you into debt so not everyone should have one. However, if you follow the steps below, you will be just fine.

The cardinal rule to using credit cards is to pay off your balance in full each month. Credit cards, unlike debit cards, work by using what is called a revolving line of credit. Essentially, every time you make a purchase with the card, the card issuer is loaning you the money for that purchase.

It does not come directly out of your bank account (that would be a debit card). For example, say you go onto Amazon and buy a new pair of shoes for $150 with a credit card. That $150 does not automatically come out of your bank account.

Instead, your credit card company gives Amazon $150 and it is your job to pay the credit card company back. You need to pay off the balance of your credit card each month in full. If you pay off your balance on time, you will not be charged any interest and your credit score will go up if you do this consistently.

If you fail to pay off your balance in full each month, your credit card company will charge you interest until the loan is paid off. The interest rates on credit cards can easily range from 20% to 30% so make sure that you don't spend more money on your credit card than what you have in your bank account.

Credit utilization is how much of your available credit you are currently using. For example, say that you applied for a credit card and got approved for a credit limit of $5,000 per month. This means that every month you can spend up to $5,000 per month on that credit card.

Say you are using this credit card in the first month and have put $2,000 on the card. Your credit utilization would be 40%. In other words, you are using 40% of the available credit on your new card. As a general rule of thumb, you want to aim to keep your credit utilization below 30%.

There are a few reasons for this. First, keeping your credit utilization low will positively increase your credit score. Think about it like this. If a credit card issuer gives you a credit with a $5,000 credit limit each month and every month you put the maximum on the card, it increases the likelihood that you will not be able to pay off the balance.

When you keep your credit card utilization below 30%, you are a more responsible card user according to credit score rating methods. Secondly, keeping your credit card utilization below 30% will decrease the probability that you will go into credit card debt.

For example, if you have a $5,000 credit limit and only put $1,000 on the card, your credit utilization is 20%. If you only spend $1,000 per month on a few necessities such as groceries, gas, and car insurance, it is more likely that you will have the money to pay off a smaller credit balance as opposed to a larger one.

When you first start using credit cards, you should avoid having multiple cards. If you can't handle one credit card, how will you be able to handle multiple cards? The good news is that you only need a single credit card to build your credit score.

When you get your first credit card, your top priority should be paying off your balance in full each month and keeping your credit utilization low. Once you have proven that you can handle one credit card, you can apply for another if it makes sense to do so.

In general, you do not want to shut down old credit cards even if you do not use them. For example, say that you got a student credit card from Discover in college to start building your credit. However, say that you are a few years out of college and no longer use your Discover student card. You are thinking about shutting it down.

The question is should you do this? In short, probably not for a few reasons. First, one of the factors that impact your credit score is the length of your credit history. In general, the longer you have used credit responsibly, the better your score will be.

In the example above, assume that you got your Discover student credit card when you were 18 years old. It was the first credit card you ever got. However, you are now 25 years old and primarily use a Chase credit card.

Since you opened your first credit card when you were 18 and are now 25, you have a 7 year credit history. Even if you no longer use the Discover card, it is generally a good idea to keep it open as it will show lenders that you have a 7 year credit history.

The second reason that you should not shut down the Discover card is because it will help keep your credit utilization lower as you have a higher credit limit. For example, say that your Discover card had a $2,000 credit limit and your Chase card had a $6,000 credit limit.

In total, you would have $8,000 of credit limit. In order to keep your credit utilization below 30%, you could spend up to $2,400 per month in credit. However, if you shut down the Discover card, your credit limit would now be reduced to $6,000 as you only have the Chase card.

If you shut down the Discover card, the most you could now spend to keep your credit utilization would now only be $1,800 per month. At times it can make sense to shut down an old card, but in general avoid doing so for the two reasons mentioned above.  

Another rule that you want to follow when using credit cards is to avoid applying for multiple cards within a short period of time. When you apply for multiple cards in a short period of time, you appear to be a more risky applicant to lenders that issue credit cards.

Every time that you apply for a credit card, lenders will perform a hard credit check. A hard credit check shows up as an inquiry for a new line of credit on your credit score. If you have too many inquiries for new lines of credit on your credit report in the last 12 months, it can negatively impact your credit score.

So, the question is how often can you get a new credit card. The answer is that it depends. If you have strong credit already, you can apply more frequently than if you have low credit. If you have a higher credit score, it is still a good idea to wait at least six months before applying for a new card.

If you have a lower credit score, it is best to wait at least a year before applying for a new card. Also keep in mind that when you apply for a new credit card, your score may temporarily drop as it increases risk for the lender.

However, do not panic when this happens. Remember the cardinal rule of credit cards is to pay off your balance in full each month and to keep your utilization low. When you get a new card and do these two things, your credit score will bounce back.

The last step to using credit cards in the right way is to get credit cards that make sense for you. Some credit cards focus on offering rewards around a specific area or are geared towards a certain type of person. For example, some cards are specifically designed to help you earn points that you can put towards traveling.

If you are an avid traveler, you might opt for one of these cards. If you are a student, you can apply for a student credit card. These cards are designed to help students learn how to responsibly use a credit card. Additionally, some cards are geared towards business owners.

One other type of card that is worth mentioning is a secured credit card. A secured credit card is an unusual type of credit card in which your credit limit is equivalent to a deposit. For example, when you sign up for a secured credit card you put down a deposit of $500. Your credit limit would then be equal to $500.

A secured credit card is designed for those who have limited or low credit. If you are looking to build up your credit, a secured credit card may be a viable option. Once you have chosen the type of credit card that is right for you, make sure to check the terms of the credit card such as the interest rate, rewards, and annual fee if applicable.

The bottom line is that the point of using a credit card is to build up your credit score so that you can access capital at the best rates throughout your life when it makes sense to do so. The cardinal rule of using a credit card is to make sure that you pay off your balance in full each month.

You also want to make sure to keep your credit utilization below 30% at the minimum, don't shut down old credit cards, don't have more than one credit card if you can't handle it, and don't apply for to many credit cards at one time

Credit cards can be great financial tools, but they can also ruin you financially if you fail to pay the balance off in full each month. Not everyone can handle or should have a credit card. If you can prove to yourself that you can use a credit card responsibly it is worth using one. Otherwise it is best to avoid them.