It might sound a little crazy, but it's possible to use credit cards to give your score a boost. There are a few things to consider, though, before you decide to take this route – it only works if you use your cards responsibly.
If you currently carry credit card balances, the best thing you can do is stop using your cards. Decide to use only cash or your debit card until you have your credit life under control. Seriously, you can't get out of debt by putting more purchases on your card. If you can't stop using your cards because you need them to pay for your essential expenses, such as your mortgage and groceries, you need professional help. Consider contacting a non-profit credit counselor for some guidance.
Check out the National Foundation for Credit Counseling. They can help you find an accredited agency in your area. In most cases, you get a free phone call with a counselor. For some of you, this might be all you need to get on the right track.
Okay, for those who pay their balances each month and use their cards responsibly, here are three tips for using your cards to kick your score up a notch or two (or three).
Tip #1: Keep low balances on your credit cards
Your credit utilization ratio is the amount of credit you've used compared to the amount of credit you have available. As long as you have a credit utilization ratio under 30 percent, you're fine. For instance, if you have a $1,000 credit limit on all of your cards, then you need to keep your balance under $300 (1,000 x .30).
If you're trying to boost your score into rarified territory, though, you need to keep your balances below 10 percent of your credit lines. Using the same example, that would mean you need to keep the balance below $100 (1,000 x .10).
There are five factors that make up your FICO score, and this part of your score, your utilization, accounts for 30 percent of it. That's a big percentage, so keep an eye on those balances when your goal is to improve your score. By the way, there are many versions of credit scores other than FICO, and in all them, your credit utilization is a big factor. So keep the balances under 10 percent and pay the bill in full by the due date to avoid paying interest.
Insider tip: There's a misconception that you have to carry a balance to get the account included in the score calculation. This is false. You do have to use your card, but you can charge $20 a month, pay the balance in full by the due date, and get "credit" for using credit.
Tip #2: Get a secured credit card
If you are rebuilding credit and you don't qualify for an unsecured card, using a secured card that reports to all major credit bureaus is a good way to go. Note that it's essential that the issuer reports your payment history to the main credit repositories – Experian, TransUnion and Equifax. Then pay attention to Tip #1 and keep a balance below 10 percent. Use this card responsibly and you're on your way.
Insider tip: Some issuers report secured cards to the bureaus as "unsecured," but some report the account as "secured." While this might affect a lender's decision if an underwriter looks at your report, it does not hurt your score at all. The score calculation only "sees" the account as a revolving account, and there's no penalty for having a secured card.
Tip #3: Use your credit cards to keep them from being closed
In Tip #1, you learned about keeping a low utilization ratio. Well, if you have several cards and you go for months without using one, the issuer might decide to close your account due to inactivity. If this happens, you lose the available credit associated with that card. Remember the example above with the $1,000 credit limit on all cards? Let's say you have four cards and each card has $250 limit.
If one card is closed, then your available credit is now down to $750 (1,000 - 250). If you have a $300 balance, your ratio has gone from an acceptable 30 percent ratio to an unacceptable 40 percent ratio (300 / 750 = .40, or 40 percent), which could lower your score.
To avoid having your account closed, use the card for a small purchase every month and your account should be fine. One way some consumers do this is by using the card for a recurring charge. For example, use the card for a gym membership fee. This way you use the card, but you don't have to mentally keep track of it.
Insider tip: One reason issuers close accounts that aren't active is because they earn interchange fees on your purchases. So an inactive account is undesirable to the credit card company. If your account gets closed and you want to keep it open, call customer service and ask to speak with a supervisor. Explain that it was an oversight on your part and that you'd like to keep the account open and plan to use the card every month.