Believe it or not, when you’re trying to build your credit, you have to understand how cash can hurt or help your ability to build a good credit score. I know your eyebrows are going through the roof right now, but give me a minute to explain.
How Cash Hurts Credit
If you’re trying to build credit, paying cash will not help your credit score. Cash will leave no record of how you handle credit therefore it is of no benefit to you when you’re trying to build your credit. The number one fear of individuals who are trying to build credit, is getting back into credit card trouble. It is a valid fear. But, once you understand how to use credit in a whole different way, those fears will disappear.
Credit Cards – the #1 Ways To Raise Your Scores
Credit card activity on your credit report is the number one way to raise your scores, even faster than a car loan, mortgage payment, etc. Cars and home loans are necessities, whereas credit cards are (supposed to be) discretionary, and so the weight of each activity on your credit reflects higher when you use your discretionary spending in a smart way. You must know how and what to do, otherwise credit card activity can also just as easily ruin your credit.
Let’s look at an example. Let’s say Tom – fictitious – has bad credit. Tom is paying all of his bills by cash. He’s already mentally trained himself to do this because he doesn’t have the ability to use credit to pay his bills. If Tom understood how to use credit cards to pay his bills like cash, his credit scores would benefit.
If you have a credit card or two, here’s how you can use cash & credit cards to raise your credit scores:
- First , calculate what 30-33% of your card limit amounts to. For example, if you have a credit card with a $1,000 credit limit, you’ll multiply 1000 x 0.33, which will equal $330. That amount will be the maximum amount you’ll ever carry as a balance at any time on that particular card. I’ll explain why in a minute.
- Next, you’ll want to get a checkbook registry of some kind (mobile or paper) to keep a log of your spending on this credit card. For you tech-savvy folks, a smart phone can do the trick as well.
- Your 3rd step – if you can, you’ll open an account specifically for depositing funds – we’ll call that Account “B”. It should be a checking account, and it should be tied to your primary checking account insomuch that you will be able to transfer funds back and forth between those accounts. Do not link these accounts in a way that if your current checking account (Account “A”) is overdrawn it’s pulls funds from this new checking account, you don’t want to do that.
- Now here’s the trick: when you get paid you would normally deposit your paycheck to your normal checking account (remember – Account “A”). Then you’ll use your debit card or checks to mail and/or pay your normal bills – light bill, gas bill, rent; things of that nature. Instead, what you’ll do is create a budget of the bills that you need to pay based on the the amount of cash you actually have. You will then transfer the total funds to pay those bills from account “A” into account “B”. Instead of paying bills the normal way – by cash,debit card or check, you’re now going to pay your light, water, gas, cell phone, fill up your tank, go grocery shopping, whatever your cash budget allows – with your credit card. You will start your registry with the amount of money from that budget as a debit amount (see example A) and all of the bills you pay with a credit card you will enter in the credit column.
You’ll want to keep a running tally of the amount of money you’ve spent in your check register just as if you were writing a check, until it matches your maximum allowable charge amount and then you will stop using that particular credit card. The next time you get paid you will repeat the process again. This is how you will pay your bills each month. At the end of this monthly process, your Account B should still have the FULL amount of money that you allocated (deposited) for your credit card spending budget. And it must stay there, you should not touch it under any circumstance especially if you’ve already paid the bills with the credit card. Remember, the register is just to let you know how much you have left to spend on your credit card, it does not reflect the balance in your Account B. You will do this for each card until you hit either your maximum amount you should charge (remember the max number that is 30% of you card limit?) or the total amount of all your bills, whichever is lower. If you’ve hit that 30% number, before you are done paying all your bills, pay the rest of your bills the traditional way if you don’t have any other credit cards
When your credit card bill arrives, you will pay the bill in full with the amount of money that you have sitting in Account B – this will allow you to pay off the card in full. What that also means is – and this is key – that particular credit card bill will cost you 0% in interest charges which is the equivalent of paying cash, but with the benefit of having credit activity which can and will affect your credit scores in a positive way.
Here’s my final note: you MUST NOT carry a balance of more than 33% of your credit limit during each billing cycle on any single credit card. Why? Have you ever notice at some point in your life, when you had better credit, and most of your credit cards were maxed out, your credit scores never seemed to go above a certain score, even though you paid your minimum balances every month on time for years? That’s because the bureaus look at limit-to-balance ratios – meaning someone with low balances is a lower credit risk than someone with high balances. High balance and minimum payments that linger for years means more than likely you don’t have the ability to pay off the balance and if you find yourself in financial hardships you will default and be unable to pay the card off. If you’re being honest with yourself, that summation is probably true. And the credit bureaus can assume that riskiness based on certain patterns. If you have 100% of a credit limit and you are only using up to 33% of that limit and you are paying off the balance in full, sometimes not every month, but most of the time…..your payment pattern will appear as if your risk levels are lower, thereby your scores will be higher.
I urge you to try this system if you can. Make a pledge to ditch your fear of using credit cards. Make a pledge that you will make all your bill payment activities actually lead to better credit. Make a pledge that you will use this newfound knowledge to make these important changes in your life. And realize it will take time and practice. Remember, Rome wasn’t built in a day.
Andrea Davis is a licensed Real estate broker in the state of Georgia, with many years experience working in the Atlanta real estate market. With loads of experience in the mortgage and real estate industry, Andrea is passionate about educating buyers, sellers and renters, and firmly believes in the power of education and knowledge. Send questions to her at firstname.lastname@example.org.
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