Credit cards are useful tools for building and maintaining a strong credit score. If you charge items and pay them off on time every month, your credit score will rise. That’s important; a strong credit score can help you earn lower interest rates on mortgage and auto loans, and qualify for credit cards that come with rewards programs and other perks.
But it’s also easy to misuse your credit cards. And if you do, you might find yourself facing a mountain of debt that keeps growing each month because of high interest rates. You might also find yourself with a credit score that is falling instead of rising.
Here are the five biggest mistakes that you don’t ever want to make with your credit cards, lest your credit score and your finances suffer.
1. Late or Missed Payments
Never pay your credit card bill late. If you do, the consequences are quick and severe. First, your credit card company will charge you a late fee. These vary, but usually run from $25 to $35. But that late fee is actually the least of your worries.
If you pay your bill late, your credit card company can boost your card’s interest rate. Penalty rates can rise to as high as 29.99%. This is a big financial drain. If you carry a balance on your card each month, penalty interest rates that high can make your existing debt soar every 30 to 31 days.
If your payment is more than 30 days late, your credit card company will report the late payment to the three national credit bureaus (TransUnion, Equifax, and Experian), which means the late payment will show up in the three credit reports that these bureaus maintain. Mortgage, auto, and other lenders will see the late payment whenever you apply for a loan. This will make it harder to get a loan, and if you do qualify, your interest rate will be higher. The late payment will remain on your credit report for seven years.
A late payment can also cause your credit score to drop. By how much depends on how high your credit score already is and how many other dings you have on your credit report. Payment history accounts for 35% of your credit score. If you have missed credit-card payments, then, your score can tumble.
2. Carrying a Balance Each Month
You should always pay off your credit card’s balance in full each month. If you don’t, you’ll be charged interest on what you owe. That can make your existing debt grow quickly. That’s because credit cards come with such high interest rates. If your interest rate is 17%, even a balance of $1,000 that you don’t pay off can grow rapidly.
3. Paying Only the Required Minimum
When you get your credit card bill, it will list the minimum payment you must make that month to avoid a late fee. But paying only the minimum is a big mistake; you’ll pay loads in interest over the lifetime of your debt if you only make the minimum payment each month.
Here’s an example: Say you owe $3,000 on a credit card with an interest rate of 18%. If you make the minimum payment of just $75 each month, it will take you 222 months — or more than 18 years — to pay off your debt, if you never make another charge on your credit card. You will also pay more than $3,932 in interest on that $3,000 debt.
4. Closing Unused Cards
You might think that closing a credit card that you never use is a good move. But doing so can actually cause your credit score to drop. That’s because a portion of your credit score is made up of how much of your available credit you are actually using. If you close a credit card that you no longer use and has no balance on it, you’ll immediately be using more of your available credit, which will cause your credit score to fall.
Here’s how this works: Say you have four credit cards, each with a credit limit of $3,000. This gives you a total of $12,000 of available credit. Say you also have $3,000 worth of credit card debt spread out among your four cards. If one of your cards has no balance and you close it, you now have just $9,000 worth of available credit. If you still have that $3,000 of credit card debt, you are immediately using a higher percentage of your available credit. Put simply, $3,000 of credit card debt looks better when you have $12,000 of available credit than it does when you have just $9,000.
5. Taking Out a Cash Advance
Your credit card might allow you to take out a cash advance. Even if you are short of cash, don’t do this. It’s barely better than taking out a payday loan.
First, you’ll usually be charged a fee for taking out a cash advance, usually ranging from 2% to 4% of whatever advance you take. That’s not the worst part, though. Your credit card company might charge a higher interest rate on the money you take out through a cash advance. The interest will start accruing immediately. There is no grace period as with other credit card purchases.
Some credit card companies won’t even allow you to pay off your cash advance dollars until you first pay off your more traditional credit card debt. If you carry a balance each month, it might take you a long time to pay off the higher-interest-rate debt from a cash advance.
Credit cards can be terrific financial tools when used wisely. Avoid the five traps above and make the most of your credit.
This article first ran on Wisebread.com, a community of bloggers here to help you live large on a small budget. Read more from Wisebread: