How Credit Cards Affect Your Credit Score

Your credit score is an important number. It can affect your ability to obtain a credit card or borrow money in the form of a personal loan, a car loan, or a home mortgage. It can also dictate the interest rate you'll have to pay if you are able to borrow. What's more, credit scores are often used for purposes that go beyond credit, such as setting your insurance premiums and even influencing whether a landlord will rent to you or an employer hire you.

Credit cards can be one of the major influences on your credit score, and how you use them can either help your score or hurt it. Here is what you need to know.

How Credit Scores Work

First, some background on how credit scores are calculated.

The predominant credit scores today are FICO scores. There are a variety of FICO scoring models, including specialized ones for mortgage lenders, auto loan lenders, and credit card issuers. If you have at least one credit score you have probably have several of them and they may not match perfectly.

FICO scores are based on the information in your credit reports, which is supplied to the three major credit bureaus by your current and former lenders. Credit reports include information on how much money you owe, to whom you owe it, the types of loans you have, and how consistently you have paid your credit bills month after month going back as far as seven years.

The basic FICO scoring model consists of five broad categories of information, each of which is assigned a weighting. The weightings indicate how much importance FICO assigns to that category as a possible predictor of your future credit behavior. The categories are:

Payment history. This category, which accounts for 35% of your score, refers to whether you have paid all of your credit bills each month, ever been late with one, or failed to make one altogether. For obvious reasons, prospective lenders prefer people who keep up with their bills.

Amounts owed. This is the second most important category, accounting for 30% of your score. It not only looks at how much you owe but, more significantly, how much you owe as a percentage of all of the revolving credit (like credit cards) that you have available to you—a figure known as your credit utilization ratio. In general, lenders like to see a credit utilization ratio of 30% or less, and the lower, the better.

Length of credit history. Accounting for 15% of your score, this refers to how many months or years you have had your credit accounts. Older accounts are more highly valued, assuming you've paid them on time.

New credit. Just as your score will benefit if you have older accounts, it can suffer if you've taken on, or applied for, a lot of new credit lately. Lenders can take that as a warning sign that you may be in financial trouble or headed there. This category accounts for 10% of your score.

Credit mix. The remaining 10% of your score, credit mix, refers to the types of credit you have used, such as credit cards, car loans, or a mortgage. Lenders like to see that you have handled a variety of different credit types responsibly. As the company behind FICO says, however, "Don't worry, it's not necessary to have one of each."

FICO's major competitor, VantageScore, looks at many of these same factors but assigns them slightly different weightings in some cases.

How Credit Cards Can Help Your Credit Score

In order to have any credit score at all, you generally need to have used some form of credit for some period of time. For many people, a credit card will be their first foray into the credit world.

Obtaining a credit card without a credit score can be difficult. People who are just starting out—new grads, for instance—often have no credit report at a major bureau, or a very skimpy one known as a "thin file." This doesn't mean that they have bad credit, just that there is not enough information on them yet to formulate a credit score.

To obtain a first credit card, individuals have a number of options. For example, some credit card companies offer cards aimed at this market, including student credit cards, starter credit cards, and secured credit cards. The first two act like regular credit cards, albeit with certain restrictions and possibly higher annual percentage rates.

Secured credit cards, however, are a bit different. Rather than lending you money in the form of a credit line, these cards require that you deposit a certain sum of money with the lender that you can then draw on to make purchases. After you have used your secured card for a period of time, you can usually graduate to a conventional credit card.

Any of these types of credit cards, responsibly used, can help you build a credit history and a solid credit score.

Still another option is becoming an authorized user on someone else's credit card, such as a family member's.

Once you have a credit card (or several of them), continuing to pay it on time will help you maintain and improve your score.

How Credit Cards Can Hurt Your Credit Score

As noted above, failing to pay your credit card bills on time will damage your credit score, as will applying for too many new cards in a short period. The first of those two is more important, however, because of the way credit scores weight different information.

Letting your credit utilization ratio get too high—particularly if you max out your cards—also hurts.

Ironically, perhaps, closing a credit card account can also impair your credit score, by reducing the average age of your accounts. For that reason, it often makes sense to keep a card account open even if you rarely or never use it. An exception might be if it carries an exorbitant annual fee that you can't get out of.

The Bottom Line

Using credit cards responsibly can help you build a strong credit score. On the other hand, failing to pay your bills on time, even inadvertently, will hurt your score. If you're the forgetful type, there are a variety of ways to make sure your bills get paid, including signing up for automatic payments from your bank account. If you become overextended and can't afford your credit card payments, there are also sources of help available, including nonprofit credit counseling organizations.