Plenty of personal finance pundits love to tell people to cut up their credit cards. And that's understandable -- the lure of easy revolving credit has drawn millions of people into pits of high-interest debt from which they may struggle to extricate themselves. But if you're in a solid fiscal position, and you don't already have one, you probably should. Consider the case of Collin, 26, whose credit history thus far consists solely of regular payments on his student loans and his car loan. He asks whether adding a credit card to his wallet would improve his credit score. Yes, say Motley Fool Answers hosts Alison Southwick and Robert Brokamp and their special guest for the July mailbag show, Ross Anderson, a certified financial planner at Motley Fool Wealth Management -- a sister company of The Motley Fool. In this segment from the podcast, they offer him some advice about the best way to pick his new plastic, the right ways to use it, and how long it will take to start lifting his credit score.
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This video was recorded on July 30, 2019.
Alison Southwick: Our next question comes from Collin. "I'm 26 years old and my credit history is comprised solely of student loans and a car loan. No missed payments for either, resulting in a fairly decent credit score of 730, apparently held back mostly by my age. Could my credit be improved by signing up for a credit card? How about security when shopping online, and if so, how do you recommend shopping around for a credit card?"
Ross Anderson: Collin, I love that you asked this question and I love the framing of the question; that it wasn't, "I've got some extra stuff that I want to buy, so should I get a credit card so I can buy it?" You're asking it the right way. You're looking to improve your credit.
Let's talk about what goes into that credit score first of all, because there's a couple of big factors. The biggest piece of it is your payment history, so by continuing to pay on your student loans and your car loan -- no missed payments, don't be late -- that's a huge part of it.
The next really big chunk is what's called a utilization ratio. This is, I think, poorly understood, but it's basically how much of the credit that has been extended to you is being used. It's a very big deal.
The next is going to be how often are you checking your credit? How many hard inquiries are against the credit? How many times are you letting people ping it and see if you're creditworthy?
And then the final thing is going to be your length of accounts and how long they've been open, so that account history and then also the credit mix. They look at how many different types of accounts do you have? Is it just a student loan? Is it all credit cards?
In this case I think it is going to improve your credit. It may not be immediately in the short term, but I would have you get a credit card and I would be very careful with it. So a couple of things to note.
No. 1 on that utilization ratio, the number they really look for there is 30% or less. If you get a credit card and they give you $1,000 limit, you never want to have the balance sitting at more than $300 on that credit card. Being very responsible with the amount that they give you is going to improve your credit.
No. 2 is you're going to start the clock on that credit history so that you've got a longer length of time that you leave that card open. That's going to help. And again, it's going to help the credit mix a little bit.
Where you may take a hit in the short term is because they're checking it, so you're going to have a new hard inquiry on your report. That's not a big deal. Again, I think over a couple of months' time you're going to see it tick up from a 730 to maybe even higher than that, assuming that you're using the credit very responsibly. Pay it off every month. Don't pay interest. I think it is a good idea for you.
There's a bunch of resources online. The Motley Fool now has one called The Ascent. If you go to Fool.com, under the personal finance tab there's a bunch of resources on rated credit cards. I would probably look for one with no fee. You're not necessarily in the points game, yet.
If you ultimately start spending more and traveling, you might want to get into a points or rewards credit card where you're probably have an annual fee in exchange for some nice perks, but for your first one I would definitely go no annual fee and try to get a low interest rate. Don't carry an interest-bearing balance on it.
Robert Brokamp: He also asked about the security of buying things online. In the handful of times that we've had problems, including maybe two months ago we were charged around $700 on our credit card from Nordstrom. The credit card company has basically eaten that cost. You just have to stay on top of it and keep an eye out for it.
Anderson: As long as you open up a case with a fraud department, what they will normally do very quickly is shut down the card and send you a new one. Most of these companies -- I don't know of any that don't -- are not going to hold you responsible. That still doesn't mean to be crazy with your data. Don't put it out there on your Facebook posts. Don't put a photo of your credit card number anywhere on social media. I've actually seen that.
Southwick: Look! I got a new credit card!
Anderson: Be as responsible as you can. Try and work with merchants that are reputable. Look for the security lockbox thing on your web browser if you're going to put your number in, but most of the time you're not going to have a lot of liability there.