A credit card can be a great way to build your credit, but to really maximize its effect, you need to understand how it relates to your credit score.
There are several credit scoring models, but the most common one used by lenders is the FICO scoring model. Several categories of information contained in your FICO score can be maximized if you use your credit card responsibly.
Boost Your Score By Treating Your Credit Card Right
Pay your bill on time: Your payment history makes up 35% of your FICO score, and is the most straightforward category to master. Basically, if you always pay your credit card bills on time, this part of your score will be just fine. And, the longer you maintain a perfect track record of on-time payments, the better your score will get.
Use less than 30% of your credit limit: 30% of your FICO score comes from a category called "amounts owed," but its name is somewhat misleading. More important than the actual dollar amount you owe on your credit cards, loans, etc., is the amount you owe relative to your available credit (or your original balance on loan accounts).
Many experts suggest you keep your credit utilization below 30% of your available credit. In other words, if you have a credit card with a $5,000 limit, you should try to maintain a balance of less than $1,500. And, lower is even better. The average consumer with a FICO score of 800 or higher only uses 7% of their available credit.
Keep your credit card open: 15% of your FICO score comes from the length of your credit history, which includes the age of your oldest account and the average age of your accounts. So, if you keep your credit card for a long time, your average account age will increase, and your score could rise. But don't just let it sit idly in your wallet. Use it occasionally (and pay it off right away) in order to give the card company something good to report to the credit reporting bureaus.
Don't apply for too many new credit cards: 10% of your score is made up of your new credit, meaning how many of your accounts were recently opened, and how actively you have been looking for credit. So, if you only open new credit card accounts when you need them, this category should take care of itself. Apply for too many lines of credit, and red flags start to wave.
In a nutshell, as long as you use your credit cards responsibly and follow these guidelines, they can help to build up your credit score for a variety of reasons.
Matthew Frankel owns shares of American Express. The Motley Fool recommends American Express. The Motley Fool owns shares of Capital One Financial.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.