How to use your credit card to build an excellent credit history

By now, I assume that you already have a credit card. If so, this post is intended for you.

Back in mid-January, 2012, I got my first credit card, a secured credit card from Bank of America. At the time, I wasn’t aware of any credit card perks that I told you about in my first blog post. All I knew was that I would be rewarded for any charges put on the card, and that it’d be easier to dispute a charge on my credit card than that on my debit card. I also knew that you were supposed to use your credit card for the account to be reported in your credit history. So I did what made perfect sense to me: put all charges, everyday, on my credit card. I completely abandoned my debit card except for ATM withdrawals.

Despite putting all charges on my credit card, I never reached the $2,000 limit. In fact, my credit card never reported a balance greater than $1,200 even though there was one time my credit card balance came very close to $2,000 – perhaps near $1,900. You may wonder why.

Creditors do not always report credit card accounts to credit bureaus. They only do so at the monthly statement closing date, which is set by the creditor but can be changed after a certain number of statements. Whatever you do between the two closing dates doesn’t alone determine the balance reported. Here’s what might’ve happened the month where I came close to $2,000 but my credit card account only reported a balance of $100.

I bought a round-trip ticket to Asia costing $1,000. All other purchases during the month add up to $900. So the total charges to the card are $1,900. 4 days before the statement closing date, which is the 6th of each month for my card, I transfered $1,800 from my BofA checking account to the card, bringing the balance down to $100. Since BofA’s credit card payment takes about 2 days to process, 2 days before the statement closed, my credit card balance was only $100. I did not put any more charges on my card. So the statement reported $100 on my balance, and that’s what shows up on my credit report as my current balance until the next statement closing date.

So you see, by paying the balance a couple of days before the statement closing date, I avoid having a huge balance reported to the credit bureaus. Why do I care about this? Well, from a creditor’s point of view, the less you use the loan available to you, the stronger a financial position you have, and the less risky you are as a borrower. A balance of $1,900 versus a balance of $100, both on a $2,000 limit, which one more strongly implies a borrower in financial troubles? You get the idea. Especially when you are building a credit history, it is very important to keep the reported balances low. This is going to determine when you can apply for future credit cards and what kind of cards you’ll be eligible for. Not alone, but it’s an important factor.

One common question I was often asked when I talked to my personal bankers about applying for a credit card was: “Do you carry a balance”? My answer to that? “No!” Wait, why do I say “No”, even though my credit card account reports a non-zero balance? As it turns out, “carrying a balance” has a very specific meaning in the world of credit cards. Back to my hypothetical scenario where my credit card account reports a balance of $100. My card’s balance due date is 25 days after the statement closing date, and the minimum payment on the balance of $100 is $15. I have 25 days to pay the $15. I do it on day one. Actually, I go beyond that, and pay the entire balance of $100 right after the statement was closed. This means that I pay the balance in full and do not carry a balance. On the other hand, if I only made the minimum payment and maintained the other $85 past the next statement closing date, you would “carry a balance” of 85$, and it will accrue interest. The interest rate is known as APR, or “Annual Percentage Rate”, which can go beyond 30% per year. Carrying a balance isn’t bad per se, but it’s costly because of interest accrual. If possible, always pay in full.

OK, I agree that I should always make at least the miminum payment, and always try to pay in full if possible. But how do I make a credit card payment? If you’re an international student like I used to be, you may find yourself asking this question. I am going to be honest with you. I know of only one way, the quickest way, to pay my credit card balance. For every credit card that I have, there is a function that allows me to connect my bank account to the credit card account. Every time I want to make a payment to my credit card, I click a couple of buttons to transfer the cash from my bank account to the credit card. Some credit card accounts even allow you to set up an automatic payment with several options: pay a fixed amount on a particular day of the month, pay the balance in full at the statement closing date, etc. I know that some people go to a bank to pay the credit card balance. I have no idea how you do that, and I honestly don’t need to know. Making electronic payments saves me the time, and automatic payments give me peace of mind. As your personal finance becomes more developed, you do not want to waste the time and energy going to multiple banks to make simple financial transactions.

I would like to remind you that different creditors have different payment processing times. To make sure you don’t miss a payment, you should pay right after the statement closes if automatic payment is not an option. When you have a credit card,

NEVER, EVER MISS A PAYMENT!!!

That also means, never make a payment late. Being late on a minimum payment will result in a penalty APR which will stay on your credit card forever, but worse, it will be a stain on your credit history that will take years to fix. If you are in the process of building your credit history, being late on a payment will set you back a couple of years. So, seriously, do not miss a payment. Ever.

I am going to stop typing and go watch the 2012 election coverage with my friends in New York. If you voted today, I’m proud of you.