Most Americans know that it's important to build credit but many don't know how. If you're one of those confused about how to build credit, you're not alone.
In 2019, CNBC reported that around 40% of Americans don’t know how credit scores work. This is a disappointing but not altogether surprising statistic since credit-building is still absent from curriculum at most schools. Good for you for seeking out this valuable information!
Today, let's cover some credit-building basics. In this article, I'll share some tips on how to build credit quickly and easily.
I have a credit card I'd like to cancel, but I don't know if I should. I'm afraid it'll hurt my credit score. Today I'm going to walk you through in real time as I evaluate this decision. Then I'm going to explain how to cancel a credit card, no matter why you want to do so.
I normally don't pay much attention to my credit score. I know that it ranges between 800 and 820, so I don't worry about it. With a score like that, I'm considered to have "exceptional credit", and that's good enough for me. (Kim's very proud that she has a higher credit score than I do, by the way.)
That said, for the past several years I've been carrying a credit card that I don't want or need. It's a Chase British Airways card that I signed up for in 2011. It's a fine card, but I never use it because I have better ones. My primary credit card right now is the Chase Sapphire Reserve, which I use for 99% of my personal credit transactions.
Basically, I'm paying $75 per year -- the British Airways card's annual fee -- for nothing...except to maintain my credit score. I don't like it. I'd rather cancel the card and take a temporary hit to my credit. But is it bad to cancel a credit card? And if it's bad, how bad is it?
I've decided to document the process! Let's find out together.
One thing that I've taken to heart is debt reduction. In my case, student loans. I refinanced a while back to get a lower rate and have been paying almost triple the monthly minimum to accelerate payoff. The goal was to finish the loan payments a few months before we buy our first home (which we are currently in the middle of saving for our 20% down).
But I've encountered a sort of catch-22. As the individual loans get rolled off when they get paid, it's been hurting my credit score because my average age of credit is dropping. (I'm 27 years old.) This is exactly what I don't need before applying for a mortgage.
For today's edition of "back to basics" month at Get Rich Slowly, we're going to talk about credit scores. What is a credit score? Why should you care?
As you go about your life, you leave a trail of transactions. You take out a mortgage, you buy a new car, you use your credit card to buy new clothes and your debit car to purchase groceries.
Every month, your creditors -- the companies to which you owe money -- send info about your recent activity to a variety of credit reporting agencies (commonly referred to as credit bureaus). Each agency collects this info into a file called a credit report.
Your credit report is a history of how well you've managed your credit. It contains info about where you've lived, how much you've borrowed, and whether you tend to pay your bills on time. It also notes if you've ever filed for bankruptcy.
The credit bureaus -- Equifax, Experian, and TransUnion -- sell your credit report to other businesses so they can decide whether to lend you money, sell you insurance, rent you a home, or give you a job.
Credit reports may be boring, but they're vitally important because they provide the basis for your credit score.
How to Get Your Free Credit Report
The U.S. government has mandated that consumers be allowed to view their credit reports from each of the three major reporting agencies once every year. This is easy to do via the free AnnualCreditReport.com website. (Beware of scammy lookalikes. This one is the official government-sanctioned site.)
To get your report, you need to provide some basic info like your Social Security number. You might also need to answer some questions about current and/or past accounts. Sometimes these questions get tricky if you don't have quick access to your files. (When Kim had to check her credit report recently, she couldn't remember the amount of her mortgage payment from 2005. Her request was denied.)
If you'd like, you can obtain reports from all three credit reporting agencies at once. Or, you can stagger your requests, possibly requesting one report every four months from a different agency.
Your Credit Score
While your credit report collects info about your debt history, your credit score is a single number that summarizes all of that data.
It's back to basics month at Get Rich Slowly! Today, we're going to take a l-o-n-g look at how to use credit cards wisely. Believe it or not, credit cards can be a useful tool -- so long as you don't fall into debt.
For a long time, I thought credit cards were evil. Starting in college, I abused credit cards. As a result, I ended up deep in debt. Those two decades of debt sucked, and they led me to believe that credit cards were dangerous.
Well, credit cards are dangerous -- but they're not evil. Credit cards are a tool. Like any other tool, credit cards can be used to build or to destroy. Just as you'd treat a chainsaw with respect, you need to be careful with credit to avoid hurting yourself. If you use credit cards wisely, they can actually give you a financial edge!
Because this is a long article, I've create a table of contents so that you can jump to the section you need. (Or, you can read the entire thing, of course.)
Table of Contents
How Credit Cards Work
First, let's review some basics.
When you buy something with a credit card, you're taking a small loan from the card issuer -- Bank of America, Capital One, your local credit union -- and you owe the issuer that amount. If you pay your balance in full each month, the card basically gives you a short-term, interest-free loan. You're taking advantage of "float".
This free float is a fine thing -- so long as you pay your balance every month. But if you carry a balance, the advantage of float vanishes. Anything you might have gaines is lost to fees and high interest rates.
How many Americans carry balances and how much debt does the average cardholder owe? There's a lot of conflicting data out there, but one reliable source of information is the Federal Reserve, which every three years publishes its Survey of Consumer Finances. The latest study, from 2016, found that:
- 43.9% of American families have credit card debt, and
- the average amount owed is $5700.
Clearly, lots of Americans continue to struggle to use credit cards wisely.
That said, not everybody who uses credit cards goes into debt. In fact, the Survey of Consumer Finances shows that over half of Americans use credit cards without going into debt. They treat them as a convenience.
True story: Last year, I went into a bank to apply for a new travel credit card. During the half-hour process, I chatted with the banker. "We banks don't like people like you," he told me. "I'm sure you're a nice guy, but you pay your bill every month. We don't make any money on you. Fortunately, 90% of people who use credit cards suck with money!" He told me banks are willing to lose money on the handful of folks who use credit cards wisely because they make so much money on the people who abuse them.
Last month, Kim was a victim of identity theft. Somebody used her debit card to make a large purchase of cosmetics.
The thief first tried a couple of test transactions for amounts of $0.01 and $0.00. (How is a $0.00 transaction even possible? I have no idea.) When those worked, she went all-in. She charged $555.90 to the account.
Fortunately, Kim has an excellent bank. USAA both phoned and texted to let her know something seemed suspicious. Then, over the next week, they worked with her to keep disruptions as minimal as possible.
Fire can be one of the most destructive forces on earth, and yet some say civilization began when we figured out how to harness its power. Credit cards are the same. Ask any long-time reader of Get Rich Slowly if credit cards are good for anything, and you might get a response like: “They're to be ripped up and burned in an atmosphere-polluting bonfire of relief!”
There was good reason to hold that opinion back then. In the days leading up to the Great Recession, a lot of consumers were getting burned by the trap of easy credit and conspicuous consumption. Frankly, the weight of his own credit card debt is what spurred J.D. Roth to start Get Rich Slowly in 2006.
It's easy to visualize the situation from the chart below. Credit card debt was becoming the largest category of non-mortgage debt in America at that time.
According to a 2013 Nilson report, credit and debit card fraud were the cause of over $11.2 billion in losses in 2012. And if you think that sounds bad, just wait; it's expected to get much worse.
As USA Today reported last year, hackers and scammers have turned stealing credit card numbers into an art form. By focusing on major retailers such as P.F. Chang's, Target, and Home Depot, they can score thousands of credit card numbers in one fell swoop -- numbers that are then packaged and resold for a profit.
And stolen credit card numbers aren't as cheap as one might think; they often pull in big profits. According to Neal O'Farrell, founder of the non-profit Identity Theft Council, stolen numbers are often sold for $120.
Over the past 12 months, I have used credit card rewards to finance the bulk of our trips to Jamaica, Las Vegas, Denver, New Orleans, London, Paris, and St. Maarten. And in the process, I've also cashed in a five-figure sum of hotel loyalty points, airline miles and rewards. Of course, I blame part of this on my love of family travel, but it also has to do with how I make a living. Since I'm a points-and-miles blogger for Frugal Travel Guy, it would be pretty weird if I never went anywhere.
Aside from the questions I hear about earning points and miles and booking award travel, I get a lot of questions on the financial aspects of these trips. Are credit card rewards counted as taxable income? How about bank bonuses? If the fine print isn't all that specific, how can I tell?
Are Bank Bonuses Taxable?
We've all gotten at least one of these offers in the mail. They say something like, "Open a new savings account with XY Bank and receive a $300 bonus after setting up direct deposit" or "Earn a $250 bonus after making 10 qualifying transactions with your bank debit card."
Americans might be more responsible now than they were in the early 2000s when it comes to the use of credit. At least, that's what the evidence from a Gallup poll taken earlier this year seems to suggest.
The Gallup poll, which was based on random telephone interviews with 1,026 adults, shows that a full 48 percent claim to pay their credit card balances in full when the bill comes due. Not surprisingly, the opposite group, those who carried a balance each month, came in at a record low percentage since Gallup began recording this metric in 2001.
But the poll went further to reveal more about the secret lives of credit card users in the United States, and how the use of credit affected overall debt levels. For example, it showed that the average American carries 2.6 credit cards on average, but the figure jumps to 3.7 when you remove those who don't carry a credit card at all from the equation. Furthermore, the average American carried $2,426 in credit card debt when this poll was taken. However, exclude those without a credit card and the figure quickly jumps to $3,573. So, what does this mean?