“Used wisely, credit is an important tool in your financial toolbox. Using credit cards in the right way can help you build wealth and get better loan terms.” – Stefan Ross, VP, credit card products at Fidelity Investments.

There are many reasons to use credit cards instead of cash or debit. It could be for signup bonuses, cashback, frequent flyer miles, security or to build credit. Dangers such as overspending and overwhelming debt should be considered as well.

It’s all about how you use them. Our friend Joanna had quite a learning experience as she decided to work on her credit card skills. Together, we came up with a general guide to maximize her usage based on her experience. So, what did Joanna learn?

The Importance of Credit Scores

Credit scores have a tremendous impact on your quality of life. Credit isn’t simply used to finance large purchases, in which companies decide whether you are trustworthy enough to make payments. Bad credit can keep you from renting apartments and leasing cars (in addition to purchasing). In the worst-case scenario, an employer might use a score to decide between candidates seeking a position. Most of the activity on Joanna’s credit cards will affect her credit score in one way or another. Scores are determined by five different categories of information in a credit report:

• Payment history.
• Utilization.
• Length of credit history.
• Recent activity.
• Overall capacity.

If Joanna wanted to, how could she improve her score with credit cards?

Building Credit with Credit Cards

A secured credit card would be the best bet for Joanna to improve her bad credit.

These types of credit cards have a high approval rating. The issuer lowers their risk by requesting money upfront from applicants before opening a credit line. If used responsibly, Joanna’s score would slowly but surely increase. She needs to adhere to some key points.

• Ensure consistent and timely payments.
• Add the payment of the entire monthly balance into a personal budget plan.
• Try not to exceed 25% of the credit line.

“Whatever you owe on the card at the end of the month—even if you pay it off in full—is divided by your available credit limit to get a utilization ratio. The closer your ratio is to 100 percent (maxed out), the worse it is for your credit because it indicates you might be overextending yourself.” – David Weliver, MoneyUnder30

There’s an alternative method available, too. Joanna can become an authorized user on someone else’s credit card. Whether it’s a close friend or family member, some issuers report the primary holder’s credit card payment history on authorized user’s credit files. This way, her score can benefit without even using or having the card!

Setting Sensible Limits 

“U.S. credit card debt at $870 billion at the end of 2018.” – Federal Reserve Bank of New York.

Initially, Joanna intended to use all the available credit and then pay minimum payments. This can be a trap. Along with each minimum payment, she will be charged interest on the balance each time she pays. This is the reason said balance should be kept as low as possible. No one should spend more than they have, if it can be helped.

If you (or Joanna) need to make a large purchase to pay over time, ask yourself these questions first:

• “Can I save up for this and purchase it later?”
• “Can I get a card that charges no interest for the period of time it will take to finish paying?”
• “Have I looked into a personal loan?”

If any of these questions inspire a “yes,” perhaps the pesky interest charges can be avoided.

Avoiding Credit Dependency

According to survey data by the financial advisory site, The Ascent, 1 in 5 respondents were depended on credit cards to cover basic living expenses.

It’s common to use a credit card for a medical bill or another large/unexpected expense. This would most likely be a one-time event. Joanna considered using her card to pay her rent which would be a recurring expense. In this case, what would she do the following month?

To pay essential and recurring expenses, she should only use a credit card if she intends to pay it back in full the very same month. Otherwise, her debt might experience a snowball effect, increasing exponentially.

A recent report by CNBC shows credit card crime as the second largest fraud type in the U.S.

Monitoring Reports & Statements

Nurturing good habits and taking adequate steps to maintain a high credit score isn’t enough. Joanna will have to learn to check statements and reports on a monthly basis. Some important things to look for on credit card statements are:

• Unknown charges or companies.
• Duplicate charges.
• Unusual or very large charges.
• Changes in direct debit amounts.

There are many personal finance websites that provide free credit report information. Some credit card companies provide FICO scores along with each monthly statement as well. 

These tools are useful in order to monitor credit building efforts and to stay vigilant of fraudulent charges. Federal law allows for a free credit report at least once a year from Equifax, Experian and TransUnion. AnnualCreditReport.com gives access to these reports online or by phone. She will need to keep a watchful eye for errors, discrepancies and fraud. 

Three important things to look for on credit reports:

• Incorrect information.
• Unrecognized accounts.
• Negative events that should have been expunged.

 Credit card fraud is a growing epidemic, as shown in the chart below.

Practicing Good Habits

Now that she has a better understanding of her credit cards, it’s time to solidify some good habits.

Pay more than the minimum – Considering that the interest is calculated from the balance, paying the minimum means she would pay more overtime. Instead, it’s smart to either switch to a card with a lower rate and close the previous or try to make larger payments.

Deactivate cards for safety – Many credit card companies now provide mobile applications that allow their clients to control their cards remotely. With the touch of a button, a lost card can be turned off to prevent fraud. Clients can also turn off the cards she uses less frequently as a preventive measure.

Don’t spend more than you have – As previously mentioned, the cycle of debt incurred by overuse of credit can be damaging to a cardholder’s way of life.

Keep security in mind – A lot of web browsers store credit card information for convenience. Whereas this makes it easy to input information for a future purchase, it leaves the information exposed to theft by another user on the same device or cyber-crime. 

Convenience can be the enemy – Additionally, the ease of purchasing can cause debt to skyrocket without discipline and control. Before storing the card information in an app or browser, ask yourself whether you have the impulse control to keep yourself from overspending. 

The U.S. Federal Trade Commission highlighted the states with the most fraud complaints in the country as shown below. Being in Florida, Joanna should take her security seriously.

Earn Cash & Maximize Rewards

We left the best for last. As she used her credit cards, Joanna was actually unaware that she was collecting rewards. Imagine earning hundreds of dollars on a yearly basis simply for using the cards! Let’s take a look at some rewards available to Joanna.

Cash back – Popularized by the Discover Card in America, this credit card reward is ubiquitous in the industry. When the consumer uses the card on eligible purchases, he or she gets a refund of 1% (can be as high as 6%, depending on the issuer and the type of purchase). 

Frequent flyer miles – In the 1980’s, American Airlines began offering patrons the chance to earn miles via affiliated credit cards. Today, every airline has a similar program with one credit card or another. Usually, clients can earn a mile per one or two dollars spent using the card.

Reward points – This program gives a certain number of points per purchase, as opposed to cashback. These points are then redeemable at certain stores and for certain items. Usually, the card is cobranded by the company where you would use these points. 

Signup bonuses – The most straightforward of perks, this cash bonus (usually between $50 – $250) is credited to the card or provided via a gift card. Other versions may give points or rewards as stated above in lieu of cash. 

Joanna learned the hard way that this can be a trap. She found it easy to justify a purchase because of the rewards it would provide. They are not meant to supplement purchases. In fact, she now recommends they be ignored all together and utilized at substantial intervals. Like the cards themselves, they are tools to be used wisely. 

“Save up those miles until that Europe trip. Keep earning that cashback until it can pay for something substantial,” concluded Joanna.

In the end, there are many reasons to use them to build credit, finance purchases and use rewards. Any amount of credit comes with responsibility. Joanna is slowly but surely maximizing her score and using her credit cards flawlessly. How about you?