Credit works in mysterious, sometimes contradictory ways. If you have good financial habits and do the right thing with your money, you’d think your credit score would be in good shape. It doesn’t always work out that way, though—and sometimes smart financial moves aren’t the best credit moves.
Not using credit cards at all
According to Experian, the average credit card balance per person in the United States was $6,194. You’d think that staying clear of credit cards is a smart financial move since the high interest rates make them look like a debt trap. And you’re right to think of them as risky—they can be.
However, credit cards are very convenient and increasingly inseparable from our daily lives, whether we use them to rent a car, shop online, start a bar tab, or use for emergency spending. They’re also crucial for building credit: If you don’t have a credit history, it’s hard to get a loan, a credit card or a mortgage. What’s more, bill providers are legally allowed to charge more for customers with “risky” credit. If you don’t have credit at all, they might consider you a risk.
The trick is to build credit responsibly. You could obviously open a regular credit card and just not carry a balance, but if you’re afraid of the temptation, there are a few other options:
With these options you can safely dip your toe in the credit pool without worrying about drowning in the deep end.
Rejecting a higher credit limit
If you’re cautious about debt, your gut reaction to a credit card company offering a high credit limit might be to reject it outright. That’s a healthy response—you don’t want to tempt yourself and use credit unnecessarily, after all.
While that may seem sensible, a low credit limit actually prevents you from establishing a higher credit score, thanks to something called credit utilization. In a nutshell, credit utilization is the amount of credit you’re actually using compared to the amount of credit available to you. If your credit limit is $10,000, for example, and you have $1,000 in debt, your credit utilization ratio is 10%. The lower this ratio, the higher your score.
Of course, you can keep this ratio low by using very little debt. Another way to increase it, however, is with a higher limit. If your credit card company increases your limit to $20,000, your ratio suddenly drops to 5% and, theoretically, your score increases. In fact, here’s a breakdown of how your ratio affects your credit score, according to Credit Karma.
Note that your score at 1% utilization is better than not using any credit at all. That’s because creditors like to see that you can handle making charges and paying them off without overspending.
You’re free to request a higher limit from your credit card company, but there’s an important caveat to remember: Sometimes requests result in a hard pull or hard inquiry on your credit. This can ding your score for six months or so, but at least it’s temporary. As a result, you’ll want to be strategic about credit limit requests, and avoid hard pulls before applying for a new loan or mortgage.
Closing an old card
Let’s say you’ve just paid off your last credit card and you’re officially out of debt. The next step would be to cancel them, right? Not necessarily, as it could lower your credit score. That’s because 15% of your score depends on the length of your credit history. According to FICO, this includes:
- How long your credit accounts have been established, including the age of your oldest account, the age of your newest account and an average age of all your accounts
- How long specific credit accounts have been established
- How long it’s been since you used certain accounts
It’s not just history, either. Your credit utilization makes up 30% of your score. By closing an account you lower your available credit, which means your utilization ratio increases. As a result, your score would likely drop. However, this drop should be minimal and short-lived if you have good credit to begin with.
One way to keep your credit limit high is keeping an unused credit card open and monitoring it periodically to make sure the balance is always at zero. Depending on the card, you could also set up balance alert so you’re automatically notified when there’s been a transaction on the card. As a precaution, you can even destroy the physical card.
Settling old debts
When people want to remedy their financial screw-ups, they sometimes turn to debt settlement, which seems sensible enough at first, as your debts can be settled for much less than what you owe. There are many downsides to debt settlement, however, and it’s generally not recommend except maybe as a last resort.
It also lowers your credit score. When you settle debt, your lender agrees to take less than you actually owe. This is seen as a risk by other lenders, and it’s bad news for your credit score: A settled debt stays on your credit report seven years from the date it was settled, according to the Fair Credit Reporting Act (FCRA)
Knowing more about your credit score
Contrary to what many believe, there’s no single credit score. Companies use different scores to gauge your creditworthiness, but the most common is your general FICO score and it serves as a decent gauge of your overall credit. FICO offers some general insight into how they calculate this number: Your credit utilization, payment history, and account history make up the bulk of your score.
When you know how your score is calculated in the first place, you have a better idea of how to maintain it—sometimes in spite of your best intentions.
This post has been updated to include more current information.