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If you want to whip your finances into shape, hereâs a good New Yearâs resolution: improving your credit score.
A lot of New Yearâs resolutions fail because theyâre so extreme. Think of all the bonkers weight-loss and money-saving goals that surface at the start of every year.
This resolution is different. No extreme measures are required. But there arenât any shortcuts. Building good credit is a goal you need to commit to 12 months a year.
How to Build Good Credit in 10 Steps
Ready to make 2021 the year you finally prove your creditworthiness? Or are you looking to recover from a 2020 setback? Hereâs how to build good credit in 10 steps.
1. Stay on Top of Your Credit Reports
Itâs essential to monitor your credit reports, especially if you received a hardship agreement from a lender due to COVID-19. Under the CARES Act rules, lenders are supposed to report your account as paid in full while the agreement is in effect, as long as you werenât already delinquent. But mistakes happen. Even in normal times, about 1 in 5 credit reports contained inaccurate information.
Through April 2021, you can get one free credit report per week from each bureau. (Typically, youâre only entitled to one free credit report per year from each bureau.) Make sure you access your reports at AnnualCreditReport.com, rather than one of the many websites that offer âfreeâ credit scores but will make you put down your credit card number to sign up for a trial. File a dispute with the bureaus if you find anything you think is inaccurate or any accounts you donât recognize.
Your credit reports wonât show you your credit score, but you can use a free credit-monitoring service to check your score. (No, checking your own credit doesnât hurt your score.) Many banks and credit card companies also give you your credit scores for free.
If the bureaus agree to remove information from your credit reports, expect to wait about 30 days until your reports are updated.
2. Pay Your Bills. On Time. Every Single Month
Yeah, you knew we were going to say this: Paying your bills on time is the No. 1 thing you can do to build good credit. Your payment history determines 35% of your score, more than any other credit factor.
Set whatever bills you can to autopay for at least the minimums to avoid missing payments. You can always pay extra if you can afford it.
A strong payment history takes time to build. If youâve made late payments, theyâll stay on your credit reports for seven years. The good news is, they do the most damage to your score in the first two years. After that, the impact starts to fade.
3. Establish Credit, Even if Youâve Made Mistakes
You typically need a credit card or loan to build a credit history. (Sorry, but all those on-time rent and utility payments are rarely reported to the credit bureaus, so they wonât help your score.)
But if you have bad credit or youâre a credit newbie, getting approved for a credit card or loan is tough. Look for cards that are specifically marketed to help people start or rebuild credit. Store credit cards, which only let you make purchases at a specific retailer, can also be a good option.
4. Open a Secured Card if You Donât Qualify for a Regular Card
Opening a secured credit card is one of our favorite ways to build a positive history when you canât get approved for a regular credit card or loan. You put down a refundable deposit, and that becomes your line of credit.
After about a year of making your payments on time, youâll typically qualify for an unsecured line of credit. Just make sure the card issuer you choose reports your payments to the credit bureaus. Look for a card with an annual fee of no more than $35. Some secured card options we like (and no, weâre not getting paid to say this):
- Discover it Secured
- OpenSky Secured Visa Card
- Secured Mastercard from Capital One
5. Ask for a Limit Increase. Pretend You Never Got It
Increasing your credit limits helps your score because it decreases your credit utilization ratio. Thatâs credit score speak for the percentage of credit youâre using. The standard recommendation is to keep this number below 30%, but really, the closer to zero the better.
If you have open credit, ask your current creditors for an increase, rather than applying for new credit. That way, youâll avoid lowering your length of credit, which could ding your score.
The downside of a higher credit limit: Youâll have more money to spend that isnât really yours. To get the biggest credit score boost from a limit increase and avoid paying more in interest, make sure you donât add to your balance.
Donât believe the myth that carrying a small credit card balance helps your credit score. Paying off your balance in full each month is best for your score, plus it saves you money on interest.
6. Prioritize Credit Card Debt Over Loans
Tackling credit card debt helps your credit score a lot more than paying down other debts, like a student loan or mortgage. The reason? Your credit utilization ratio is determined exclusively by your lines of credit.
Bonus: Paying off credit card debt first will typically save you money, because credit cards tend to have higher interest rates than other types of debt.
7. Keep Your Old Accounts Active
Provided you arenât paying ridiculous fees, keep your credit card accounts open once youâve paid off the balance. Credit scoring methods reward you for having a long credit history.
Make a purchase at least once every three months on the account, as credit card companies often close inactive accounts. Then pay it off in full.
8. Apply for New Credit Selectively
When you apply for credit, it results in a hard inquiry, which usually drops your score by a few points. So avoid applying frequently for new credit cards, as this can signal financial distress.
But if youâre in the market for a mortgage or loan, donât worry about multiple inquiries. As long as you limit your shopping to a 45-day window, credit bureaus will treat it as a single inquiry, so the impact on your score will be minimal.
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9. Still Overwhelmed? A Debt Consolidation Loan Could Help
If youâre struggling with credit card debt, consolidating your credit card debt with a loan could be a good option. In a nutshell, you take out a loan to wipe out your credit card balances.
Youâll get the simplicity of a single payment, plus youâll typically pay less interest since loan interest rates tend to be lower. (If you canât get a loan that lowers your interest rate, this probably isnât a good option.)
By using a loan to pay off your credit cards, youâll also free up credit and lower your credit utilization ratio.
Many debt consolidation loans require a credit score of about 620. If your score falls below this threshold, work on improving your score for a few months before you apply for one.
10. Keep Your Credit Score in Perspective
All the credit-monitoring tools out there make it easy to obsess about your credit score. While itâs important to build good credit, look at the bigger picture. A few final thoughts:
- Your credit score isnât a report card on the state of your finances. It simply measures how risky of a borrower you are. Having an emergency fund, saving for retirement and earning a decent living are all important to your finances â but these are all things that donât affect your credit score.
- Lenders look at more than your credit score. Having a low debt-to-income ratio, decent down payment and steady paycheck all increase your odds of approval when youâre making a big purchase, even if your credit score is lackluster.
- Donât focus on your score if you canât pay for necessities. If youâre struggling and you have to choose between paying your credit card vs. paying your rent, keeping food on the table or getting medical care, paying your credit card is always the lower priority. Of course, talk to your creditors if you canât afford to pay them, as they may have options.
Focus on your overall financial picture, and youâll probably see your credit score improve, too. Remember, though, that while credit scores matter, you matter more.
Now go crush those goals in 2021 and beyond.
Robin Hartill is a certified financial planner and a senior editor at The Penny Hoarder. She writes the Dear Penny personal finance advice column. Send your tricky money questions to DearPenny@thepennyhoarder.com.
This was originally published on The Penny Hoarder, which helps millions of readers worldwide earn and save money by sharing unique job opportunities, personal stories, freebies and more. The Inc. 5000 ranked The Penny Hoarder as the fastest-growing private media company in the U.S. in 2017.
Credit card issuersÂ have consumers right where they want them, lending money at high-interest ratesÂ and earning money from many different fees. Even reward cards benefit the issuers, because all the additionalÂ perksÂ and rewards they provide are covered by the increased merchant fees, which essentially means theÂ credit card companyÂ offers you extra money to incentivize you to spend, and then demands this money from the retailers.
It’s a good gig, but some consumers believe they can beat the credit card companiesÂ and one of the ways they do this is via something known asÂ credit card churning.
What isÂ Credit Card Churning?
Many reward cards offerÂ sign-up bonusesÂ to entice consumers to apply. Not only can you get regularÂ cash back, statement credit, and air miles, but you’ll often get a reward just for signing up. For instance, manyÂ rewards credit cardsÂ offer a lump sum payment to all consumers who spend a specific sum of money during the first three months.
Credit card churningÂ is about taking advantage of these bonuses, and getting maximum benefits with as little cost as possible.
“Churners” will sign up for multiple different reward cards in a short space of time, collect as many of these bonuses as they can, clear the card balance, and then reap the rewards.
DoesÂ Credit Card ChurningÂ Work?
Credit card churningÂ does work, to an extent. Reward credit cards typically don’t require you to spend that much money to receive the sign up bonus, with most bonuses activated for a spend of just $500 to $1,000 over those first three months. This is easily achievable for most credit card users, as the average spend for reward cards is over $800 a month.
If you haveÂ good credit, it’s possible to sign up to multiple credit cards, collectÂ bonus offersÂ without increasing your usual spend, and get everything from hotel stays to free flights,Â cash back,Â gift cards, statement credit, and more.
However, it’s something that manyÂ credit card companiesÂ are trying to stop, as they don’t benefit from users who collectÂ sign-up bonuses, don’t accumulate debt, and then pay off their balance in full. As a result, you may face restrictions with regards to how many bonuses you can collect within a specified timeframe.Â
What’s more, there are several things that can go wrong when you’re playing with multipleÂ new accountsÂ like this, as all information is sent to theÂ credit bureausÂ and could leave a significant mark on yourÂ credit report.
Dangers of Churning
Even if theÂ credit card companiesÂ don’t prevent you from acquiring multipleÂ new credit cards, there are several issues you could face, ones that will offset any benefits achieved from those generousÂ sign-up bonuses, including:
1. You Could be Hit with Hefty Fees
Many reward credit cards haveÂ annual fees, and these average around $95 each, with some premiumÂ rewardsÂ cardsÂ going as high as $250 and even $500. At best, these fees will reduce theÂ amount of moneyÂ you receive, at worst they will completely offset all the benefits and leave you with a negative balance.
Annual feesÂ aren’t the only fees that will reduce your profits. You may also be charged fees every time you withdraw cash, gamble, make a foreign transaction or miss a payment,
2. YourÂ Credit ScoreÂ Will Drop
Every time you apply for aÂ new credit card, you will receive aÂ hard inquiry, which will show on yourÂ credit reportÂ and reduce yourÂ FICOÂ scoreÂ by anywhere from 2 to 5 points. Rate shopping, which bundles multiple inquiries into one, doesn’t apply toÂ credit card applications, soÂ credit cardÂ churnersÂ tend to receive manyÂ hard inquiries.
AÂ new accountÂ can also reduce yourÂ credit score. 15% of your score is based on the length of your accounts while 10% is based on how manyÂ new accountsÂ you have. As soon as thatÂ credit card accountÂ opens, your average age will drop, you’ll have anotherÂ new account, and yourÂ credit scoreÂ will suffer as a result.
The damage done by aÂ new credit cardÂ isn’t as severe as you might think, but if you keep applying and adding thoseÂ new accounts, the score reduction will be noticeable. You could go fromÂ Excellent CreditÂ toÂ Good Credit, or from Good to Fair, and that makes a massive difference if you have a home loan or auto loan application on the horizon.
Your credit utilization ratio also plays a role here. This ratio is calculated by comparing your total debt to yourÂ available credit. If you have a debt of $3,000 spread across three credit cards with a totalÂ credit limitÂ of $6,000, your credit utilization ratio is 50%. The higher this score is, the more of an impact it will have on yourÂ credit score, and this is key, as credit utilization accounts for a whopping 30% of your score.
Your credit utilization ratio is actually one of the reasons yourÂ credit scoreÂ doesn’t take that big of a hit when you openÂ new cards, because you’re adding a newÂ credit limitÂ that has yet to accumulate debt, which means this ratio grows. However, if you max that card out, this ratio will take a hit, and if you then clear the debt and close it, all those initial benefits will disappear.
You can keep the card active, of course, but this is not recommended if you’re churning.
3. You’re at Risk of AccumulatingÂ Credit Card Debt
EveryÂ new cardÂ you open and every time yourÂ credit limitÂ grows, you run the risk of falling into a cycle of persistent debt. This is especially true whereÂ credit card rewardsÂ are concerned, as consumers spend much more on these cards than they do on non-reward credit cards.
Very few consumers accumulateÂ credit card debtÂ out of choice. It’s not like a loanâitâs not something they acquire because they want to make a big purchase they can’t afford. In most cases, the debt creeps up steadily. They pay it off in full every month, only to hit a rough patch. Once that happens, they miss a month and promise themselves they’ll cover everything the next month, only for it to grow bigger and bigger.
Before they realize it, they have a mass ofÂ credit card debtÂ and are stuck paying little more than the minimum every month.Â
If you start using a credit card just to accumulate rewards and you have several on the go, it’s very easy to get stuck in this cycle, at which point you’ll start paying interest and it will likely cost you more than the rewards earn you.
4. It’s Hard to Keep Track
Opening one credit card after another isn’t too difficult, providing you clear the balances in full and then close the card. However, if you’re opening several cards at once then you may lose track, in which case you could forget about balances, fees, and interest charges, and miss your chance to collectÂ airline milesÂ cash back, and other rewards.
How to Credit Churn Effectively
To credit churn effectively, look for theÂ best rewardsÂ and most generousÂ credit card offers, making sure they:
- Suit Your Needs:Â A travelÂ rewards cardÂ is useless if you don’t travel; a store card is no good if you don’t shop at that store. Look forÂ rewards programsÂ that benefit you personally, as opposed to simply focusing on the ones with the highest rates of return.
- AvoidÂ Annual Fees:Â AnÂ annual feeÂ can undo all your hard work and should, therefore, be avoided. Many cards have a $0Â annual fee, others charge $95 but waive the fee for theÂ first year. Both of these are good options forÂ credit card churning.
- Don’t Accumulate Fees:Â Understand how and why you might be charged cash advance fees and foreign transaction fees and avoid them at all costs. The fees are not as straightforward as you might think and are charged for multiple purchases.
- Plan Ahead:Â Make a note of theÂ bonus offerÂ and terms, plan ahead, and make sure you meet these terms by theÂ due datesÂ and that you cover the balance in full before interest has a chance to accumulate.
- Don’t Spend for the Sake of It:Â Finally, and most importantly, don’t spend money just to accumulate more rewards. As soon as you start increasing your spending just to earn a few extra bucks, you’ve lost. If you spend an average of $500 a month, don’t sign up for a card that requires you to spend $3,000 in the first three months, as it will encourage bad habits.Â
What Should You do if it Goes Wrong?
There are many ways thatÂ credit card churningÂ could go wrong, some more serious than others. Fortunately, there are solutions to all these problems, even forÂ cardholdersÂ who are completely new to this technique:
Spending RequirementsÂ Aren’t MetÂ
If you fail to meet the requirements of the bonus, all is not lost. Your score has taken a minor hit, but providing you followed the guidelines above, you shouldn’t have lost any money.
You now have two options: You can either clear the balance as normal and move onto your next card, taking what you have learned and trying again, or you can keep the card as a back-up or a long-term option.Â
Credit card churningÂ requires you to cycle through multiple issuers andÂ rewards programs, never sticking with a single card for more than a few months. But you need some stability as well, so if you don’t already have a credit card to use as a backup, and if that card doesn’t charge high fees or rates, keep it and use it for emergency purchases or general use.
Creditor Refuses the Application
Creditors can refuse an application for a number of reasons. If this isn’t your first experience of churning, there’s a chance they know what you’re doing and are concerned about how the card will be used. However, this is rare, and in most cases, youâll be refused because yourÂ credit scoreÂ is too low.
Many reward credit cards have a minimumÂ FICOÂ scoreÂ requirement of 670, others, including premiumÂ American ExpressÂ cards, require scores above 700. You can find more details aboutÂ credit scoreÂ requirements in theÂ fine printÂ of allÂ credit card offers.
YourÂ Credit ScoreÂ Takes a Hit
As discussed already, credit card churning can reduce yourÂ credit scoreÂ by a handful of points and the higher your score is, the more points you are likely to lose. Fortunately, all of this is reversible.
Firstly, try not to panic and focus on the bigger picture. WhileÂ new accountsÂ and credit length account for 25% of your total score,Â payment historyÂ and credit utilization account for 65%, so if you keep making payments on your accounts and don’t accumulate too muchÂ credit card debt, your score will stabilize.
You Accumulate Too Much Debt
Credit card debtÂ is really the only lasting and serious issue that can result fromÂ credit card churning. You’ll still earn benefits on a rolling balance, but your interest charges and fees will typically cost you much more than the benefits provide, and this is true even for theÂ best credit cardsÂ and the most generous reward programs.
If this happens, it’s time to putÂ credit card churningÂ on the back-burner and focus on clearing your debts instead. Sign up for aÂ balance transferÂ credit card and move your debt to a card that has a 0% APR for at least 15 months. This will give you time to assess your situation, take control of yourÂ credit history, and start chipping away at that debt.
What is Credit Card Churning? Dangers and Benefits is a post from Pocket Your Dollars.