Many people have made the mistake of thinking building a good credit score requires that you go into debt, but that's not actually true. Unfortunately, charging up high balances in an attempt to build your credit score can backfire. If you ever fall behind on a payment or two, you can wind up with worse credit and a mound of debt that takes years to pay back.
While borrowing money is part of building credit - after all, your credit score is based on whether you repay your debts - you don't have to overextend yourself in the journey to an excellent credit score. In fact, the opposite is true.
Understanding Your Credit Score
Credit scores are based on information in your credit report, which is created with details provided by lenders and credit card issuers that you have accounts with. Whether you pay your bills on time is the biggest factor in your credit score followed by the amount of debt you're carrying. Another smaller factors include how long you've been using credit, the types of credit you have, and any recent credit applications you've made.
How Credit Cards Factor Into Your Credit
Racking up a large amount of credit card debt can actually hurt your credit score. Anytime your credit card balances exceed 30% of the credit limit, it negatively affects your credit score. For reference that means, your credit card balance shouldn't be higher than $600 on a credit card with a $2,000 credit limit.
High balances indicate that you may be carrying more debt than you can handle and your credit score will reflect that. The lower your credit card debt, the better your credit score will be.
That doesn't mean you should cut up your credit cards and put them away simply to avoid debt. Your credit score requires some consistent activity on your credit report, but it must be responsible activity - something that shows that you're not at risk of falling behind on your bills.
An Alternative to Having Your Own Credit Card
You don't need to have your own credit card to start building your credit. Becoming an authorized user on another person's credit card gives you the full benefit of their credit history, without the responsibility of the credit card balance. As long as the primary cardholder is responsible with their account - paying the bill on time each month and avoiding high balances - you'll see your credit score rise and you never have to make a single purchase or payment. Being an authorized user is a good way to jumpstart or rebuild your credit score if you can't qualify for a credit card on your own.
What About Loans and Other Accounts?
Just like credit cards, any open loans are also factored into your credit score. This also includes student loans. Making timely monthly payments on your loans and reducing your balance over time will help build your credit score without the risk of credit card debt.
Paying off a loan ahead of schedule can help you save money on interest and frees up your monthly payment, but it may not boost your credit score. In fact, if you pay off the only account on your credit report, you may lose the benefit of consistent monthly payments. The financial benefits of early pay off may be most important to you, but keep in mind what it means for your credit score.