When it comes to managing money, there's one area many Americans have trouble with: credit cards. Americans are in lots of credit card debt, and unfortunately far too many of us carry a balance on our cards.
Your credit cards can end up costing you a lot of money if you get deeply in debt, and it takes you a long time to pay it off. And the decisions you make when it comes to credit card use can impact your credit score, which affects every aspect of your financial life.
You don't want a lower credit score or high credit card bills that derail your financial goals, so it's important to live by a few simple rules when it comes to your cards. In fact, here are six credit card rules you should know by heart.
1. Pay your balance in full every month
If you pay your credit card balance in full every month, you don't have to pay any interest on your purchases. But, if you don't pay off your cards, you'll get stuck owing interest -- which makes each purchase on your card a little more expensive.
Interest rates on most credit cards tends to be pretty high, and interest typically compounds daily. This means each day the accrued interest is added onto your principal balance, so you pay interest on the interest until the debt is paid.
If you carry a balance one month, it will be harder to pay off your balance the next month because you'll now owe the outstanding debt amount, plus interest, plus the cost of any new purchases you charged. It's likely your balance will just keep growing, and you can quickly become trapped in credit card debt that will take years or even decades to repay. Avoid this by not charging more than you can pay off when your statement comes.
2. Don't max out your credit cards
Maxing out your credit cards -- or charging up to the credit card limit -- is a bad idea.
Not only will you end up with a high balance that it could be harder to pay off, but you could also hurt your credit score. That's because maxed-out cards have an adverse impact on your credit utilization ratio, which is one of the most important factors that determines your credit score.
Credit utilization ratio is calculated based on the amount of credit you've used versus the amount available. If you have charged $300 on a credit card with a $1,000 limit, you've used 30% of available credit. To avoid hurting your credit score, you'll need to keep your utilization ratio below 30% -- but keeping it as low as you can is best.
3. Never make a late payment
Did you know a late payment could result in a credit score drop of around 60 to 110 points, depending what your score was before the credit misstep? Typically, you're reported as paying a credit card late once you're at least 30 days past due. The late payment can remain on your report for seven years.
The last thing you want is to send your credit score plummeting by not sending in your payment on time. Add the due date to your calendar to make sure this doesn't happen to you or set up autopay so the payment is made on time every month, even if you don't remember to mail in a check.
4. Don't open too many new cards at once
Having a mix of different kinds of credit is a good thing, but opening too many cards at once could cause a problem for your credit score.
One factor affecting your score is the average age of your accounts, and another is the number of inquiries on your report. Each time you apply for credit, you get a new inquiry that stays on your report for two years. Too many inquiries hurts your score. Each new card you open also reduces the age of your account history, but a longer history is better for your score.
Pace yourself when it comes to opening cards to make sure your credit score doesn't take a hit -- and avoid applying for any new cards in the weeks and months before you apply for a big loan, such as a mortgage. The last thing you want is to pay a higher interest rate for 30 years just because you opened a new credit card shortly before applying for your home loan.
5. Avoid closing old cards
Closing old credit cards can be just as bad for your credit score as opening new ones. Not only does it shorten the average age of your accounts, but it also reduces the total credit available to you. This means that any outstanding balances you have will take up a larger portion of your currently available credit lines on open accounts. Remember, the more of your credit you use, the worse your credit utilization ratio -- and the bigger hit your score will take.
6. Only pay an annual fee if it's worth it
There are plenty of credit cards out there with no annual fee, so you shouldn't waste money on a card that charges unless the fee is offset by card perks or cardholder rewards.
If you have a choice between two cards and one has a more generous rewards program but charges a fee, make sure the added rewards actually add up to enough to cover the fee. Or, if you'll benefit from card perks such as statement credits for travel purchases, be sure you'll actually use those benefits and that their value is higher enough to cover the expense of the fee. If your card comes with room upgrades but you don't travel, this perk wouldn't be worth paying for.
Don't break these credit card rules
Breaking these credit card rules could cost you big-time in terms of extra interest costs and damaged credit. Make sure you don't pay unnecessary fees, pay more interest than you need, or do anything to lower your credit score. If you follow these rules, your cards can be a great tool to help you build credit and earn rewards for everyday spending.