Building Credit with Rewards Credit Cards: A Comprehensive Guide

When it comes to managing your finances, few tools are as powerful and versatile as credit cards. In the United States, they are not only a convenient way to make purchases but also an essential tool for building and maintaining a good credit score. A high credit score opens doors to better financial opportunities, including lower interest rates on loans and access to premium credit cards.

One of the most effective ways to use credit cards to your advantage is by building credit while earning rewards. In this comprehensive guide, we will delve into the world of rewards credit cards, explaining how they work, why they are valuable, and how you can use them to establish and improve your credit score.

Understanding Rewards Credit Cards

Rewards credit cards, as the name suggests, offer various incentives and perks to cardholders. These incentives typically come in the form of cashback, points, or miles, which can be redeemed for a variety of benefits such as travel, merchandise, or statement credits. Rewards credit cards can be further categorized into:

1. Cashback Cards

Cashback cards are a popular choice among credit card users for their simplicity and immediate rewards. They offer a percentage of your spending back as cash rewards. These cards are often ideal for those who prefer straightforward, tangible rewards.

Example: Chase Sapphire Preferred® Card

• Dining and Travel: Earn 2X points on dining at restaurants and travel, including airfare, hotels, and more.
• Sign-Up Bonus: Enjoy a generous sign-up bonus after meeting a spending requirement.

2. Points Cards

Points cards are versatile rewards credit cards that accumulate points for every dollar spent. These points can be redeemed for various rewards, including gift cards, merchandise, travel, and even cashback. Points cards are attractive because they allow cardholders to choose rewards that align with their preferences.

Example: American Express® Gold Card

• Dining and Supermarkets: Earn 4X Membership Rewards® points at restaurants worldwide and 4X points at U.S. supermarkets (up to a spending cap).
• Travel Credits: Receive annual statement credits for dining and Uber.

3. Travel Miles Cards

Travel miles cards are designed for individuals who love to travel. These cards earn miles for every dollar spent, primarily for travel-related expenses such as airline tickets, hotel stays, and car rentals. If you frequently travel for business or pleasure, a travel miles card can be an excellent choice.

Example: Wells Fargo Propel American Express® card

• Wide Range of Categories: Earn 3X points on dining, gas stations, rideshares, transit, flights, hotels, and more.
• No Annual Fee: Enjoy the rewards without an annual fee.

Benefits of Using Rewards Credit Cards to Build Credit

Rewards credit cards offer several advantages when it comes to building or rebuilding your credit:

1. Establishing Credit History

For individuals with limited or no credit history, using a rewards credit card responsibly is an excellent way to start building credit. Many rewards cards are accessible to those with fair or average credit, making them a valuable tool for newcomers to the credit world.

When you use a rewards credit card, your payment history, including on-time payments and the length of your credit history, is reported to the major credit bureaus. This information is crucial in determining your credit score and establishing your creditworthiness.

2. Demonstrating Responsible Credit Use

Paying your credit card bills on time and in full demonstrates responsible credit management, which is a crucial factor in determining your credit score. Credit scoring models take into account your payment history, and consistently making on-time payments contributes positively to your credit score.

In addition to on-time payments, responsible credit use also involves maintaining a reasonable credit utilization ratio. This ratio is the amount of credit you use compared to your total credit limit. By keeping your credit utilization low, you demonstrate your ability to manage credit responsibly.

3. Improving Credit Utilization

Maintaining a low credit card balance relative to your credit limit can positively impact your credit utilization ratio, a significant factor in your credit score. A lower utilization ratio reflects positively on your credit report and can lead to a higher credit score.

For example, if you have a credit card with a $2,000 credit limit and a balance of $500, your credit utilization ratio is 25%. Experts recommend keeping this ratio below 30% to maintain a good credit score. By consistently managing your credit card balances responsibly, you can gradually improve your credit utilization and, in turn, your credit score.

4. Potential for Credit Limit Increases

Responsible use of a rewards credit card may lead to credit limit increases, which can further improve your credit score. Credit card issuers often review your account and payment history to determine whether you qualify for a higher credit limit.

A higher credit limit can benefit your credit score in several ways. First, it can lower your credit utilization ratio, as long as you maintain the same level of spending. Second, it can demonstrate that creditors trust you with a higher credit limit, which reflects positively on your credit report.

5. Earning Rewards

While building credit, you can simultaneously earn rewards, making your everyday spending more rewarding. Rewards come in various forms, including cashback, points, or travel miles. Depending on your card and spending habits, you can earn valuable rewards that enhance your financial well-being.

For example, if you have a cashback credit card that offers 2% cashback on all purchases, you can earn $20 for every $1,000 you spend. Over time, these cashback earnings can be used for various purposes, such as covering expenses, saving for future goals, or treating yourself to something special.

When selecting a rewards credit card, it’s essential to consider your spending habits and preferences to find the card that offers the most value for your specific needs. Additionally, be sure to review the card’s terms and conditions, including any annual fees and interest rates, to make an informed decision.

How to Build Credit with Rewards Credit Cards

Now that you understand the benefits of rewards credit cards let’s delve into the practical steps to build your credit using them:

1. Choose the Right Rewards Credit Card

Selecting the right rewards credit card is a critical first step in building your credit. Consider the following factors when choosing a card:

• Credit Score Requirements: Look for rewards cards that are accessible to individuals with your credit profile. Some cards are designed for those with excellent credit, while others are suitable for individuals with fair or average credit.
• Annual Fees: Pay attention to annual fees associated with rewards cards. While some cards offer valuable rewards with no annual fees, others may charge annual fees that can impact your overall cost.
• Rewards Structure: Choose a card that aligns with your spending habits and preferences. If you frequently travel, a travel rewards card may be ideal. If you prefer simplicity, consider a cashback card.
• Introductory Offers: Some rewards cards offer attractive introductory offers, such as sign-up bonuses or 0% APR on purchases for a limited time. Evaluate these offers to see if they align with your financial goals.

When choosing a rewards card, consider your specific financial goals and spending habits. For example, if you dine out frequently, a card that offers bonus rewards on dining purchases can provide significant value.

Example: Capital One Savor Cash Rewards Credit Card

• Dining and Entertainment: Earn unlimited 4% cashback on dining and entertainment, making it an excellent choice for food enthusiasts and entertainment lovers.
• No Foreign Transaction Fees: Ideal for travelers who enjoy dining out abroad.

2. Make On-Time Payments

The most crucial aspect of building credit is paying your credit card bills on time. Your payment history is a significant factor in your credit score, and missing payments or making late payments can have a detrimental impact on your creditworthiness.

To ensure on-time payments, consider setting up reminders or automatic payments. Many credit card issuers offer online account management tools that allow you to schedule automatic payments for the minimum amount due or the full balance. By automating your payments, you can avoid late fees and negative marks on your credit report.

3. Pay the Full Balance

To avoid paying interest, aim to pay the full balance on your rewards credit card each month. While it may be tempting to carry a balance, especially when rewards cards offer generous credit limits, carrying a balance only results in interest charges.

Paying the full balance not only saves you money but also demonstrates responsible credit management to credit reporting agencies. It shows that you can effectively manage your finances and avoid costly interest fees.

See More About Credit Cards.

4. Keep Credit Utilization Low

Maintaining a low credit card balance relative to your credit limit can positively impact your credit utilization ratio. Credit scoring models consider this ratio when calculating your credit score. To maintain a healthy credit utilization ratio, aim to use no more than 30% of your credit limit.

For example, if your credit card has a $3,000 credit limit, try to keep your balance below $900 to maintain a utilization ratio below 30%. A lower utilization ratio reflects positively on your credit report and can contribute to a higher credit score.

5. Monitor Your Credit

Regularly monitoring your credit is essential to ensure that your credit-building efforts are on track. You can obtain a free credit report from each of the three major credit bureaus—Equifax, Experian, and TransUnion—once a year through AnnualCreditReport.com.

Reviewing your credit reports allows you to:

• Verify that your account information is accurate.
• Identify any discrepancies or errors on your credit report.
• Monitor your progress in building credit and improving your credit score.

By staying vigilant and promptly addressing any inaccuracies or issues on your credit report, you can maintain a strong credit profile.

Example: Discover it® Cash Back

• Rotating Categories: Earn 5% cashback in rotating categories each quarter, such as gas stations, grocery stores, restaurants, and more (upon activation, up to a quarterly limit).
• Cashback Match: Discover will match all the cashback you’ve earned at the end of your first year.

Apply Now.

6. Avoid Applying for Multiple Credit Cards

Each credit card application results in a hard inquiry on your credit report, which can temporarily lower your credit score. While it’s tempting to apply for multiple credit cards to access different rewards programs, it’s essential to be selective and avoid unnecessary applications.

Before applying for a new credit card, consider the following:

• Is it necessary? Evaluate whether you genuinely need another credit card and whether the rewards or benefits justify the application.
• Timing: Avoid applying for multiple credit cards within a short period. Space out your applications to minimize the impact on your credit score.
• Credit Score: Ensure that your credit score meets the card issuer’s requirements before applying to increase your chances of approval.

By being strategic about when and how you apply for credit cards, you can minimize the impact on your credit score while still enjoying the benefits of rewards cards.

Example: Citi Premier® Card

• Dining and Gas: Earn 3X points at restaurants, supermarkets, gas stations, and on air travel and hotels.
• Annual Hotel Savings: Get an annual $100 hotel savings benefit on a single hotel stay of $500 or more.

Common Myths about Rewards Credit Cards and Credit Building

Let’s debunk some common myths associated with rewards credit cards and building credit:

Myth 1: Rewards Cards are Only for People with Excellent Credit

It’s a common misconception that rewards credit cards are exclusively reserved for individuals with excellent credit scores. While premium rewards cards often require a good credit score, there are many rewards cards designed for individuals with average or fair credit.

These cards typically offer more modest rewards and may have slightly higher interest rates or annual fees, but they still provide an opportunity to build credit while earning rewards. If you have fair or average credit, consider exploring secured credit cards or entry-level rewards cards to begin your credit-building journey.

Myth 2: Carrying a Balance Boosts Your Credit Score

Some people believe that carrying a balance on their credit card can boost their credit score. This myth likely arises from the misconception that a balance demonstrates responsible credit use. However, this belief is inaccurate.

Carrying a balance on your credit card only leads to interest charges, and it does not improve your credit score. In fact, carrying a balance can have a negative impact on your credit utilization ratio, a critical factor in determining your credit score.

To build credit effectively, it’s essential to pay your credit card bills on time and in full, rather than carrying a balance and incurring interest charges. Responsible credit use includes making timely payments, managing your credit utilization, and avoiding unnecessary interest fees.

Myth 3: Closing Old Credit Card Accounts Helps Your Credit

Some individuals believe that closing old credit card accounts can help their credit score. This belief is often fueled by the misconception that fewer open accounts lead to a more straightforward credit profile. However, this myth can be misleading.

Closing old credit card accounts can harm your credit score for several reasons:

• Reduced Available Credit: Closing an old credit card reduces your overall available credit limit, which can increase your credit utilization ratio if you continue to carry balances on other cards.
• Shortened Credit History: The length of your credit history is a crucial factor in your credit score. Closing old accounts can shorten your credit history, potentially lowering your credit score.
• Effect on Mix of Credit: Credit scoring models consider the mix of credit accounts in your profile. Closing an old credit card may affect your credit mix and potentially have a negative impact.

Instead of closing old credit card accounts, consider keeping them open and using them responsibly. Making occasional small purchases and paying them off on time can help maintain a longer credit history and positively impact your credit score.

Example: Bank of America® Customized Cash Rewards credit card

• Customizable Rewards: Choose your 3% cashback category from options like dining, online shopping, gas, travel, or drug stores.
• Preferred Rewards: Bank of America Preferred Rewards members can earn up to a 75% bonus on rewards.

Tips for Maximizing Rewards While Building Credit

While the primary goal is to build and improve your credit, you can still make the most of your rewards credit card:

1. Use Your Card for Everyday Expenses

To maximize rewards while building credit, use your rewards credit card for everyday purchases such as groceries, gas, dining, and utility bills. Many rewards credit cards offer bonus categories that provide extra rewards for specific types of spending.

For example, your card might offer 2% cashback on groceries and 3% cashback on dining. By using your card for these expenses, you can earn more rewards over time.

2. Redeem Rewards Wisely

As you accumulate rewards on your credit card, consider how you want to redeem them. Each rewards program offers various redemption options, including:

• Cashback: Convert your rewards into cash or statement credits.
• Travel: Use your points or miles to book flights, hotels, or rental cars.
• Gift Cards: Redeem your rewards for gift cards to popular retailers and restaurants.
• Merchandise: Purchase products or accessories from the rewards catalog.

Choose redemption options that provide the best value for your rewards. For example, if your card offers a higher redemption rate for travel, you may find greater value in using your rewards for trips rather than cashback.

3. Take Advantage of Introductory Offers

Many rewards credit cards offer attractive introductory offers to entice new cardholders. These offers can vary widely and may include:

• Sign-Up Bonuses: Receive a significant amount of rewards when you meet a spending requirement within the first few months of card membership.
• 0% APR Introductory Period: Enjoy an introductory period with a 0% annual percentage rate (APR) on purchases or balance transfers, allowing you to avoid interest charges for a specific timeframe.

When evaluating introductory offers, consider how they align with your financial goals. If you plan to make a significant purchase in the near future, a card with a 0% APR introductory period can help you save on interest charges. If you have a specific rewards goal in mind, a card with a generous sign-up bonus may be appealing.

4. Keep an Eye on Changing Terms

Credit card terms can change over time, affecting rewards programs and benefits. It’s essential to stay informed about any updates to your card’s terms and conditions. Card issuers typically provide notice of changes, but it’s your responsibility to review these notices and understand how they may impact your card.

Common changes that can occur include adjustments to rewards earning rates, alterations to redemption options, or updates to fees and interest rates. By being aware of these changes, you can make informed decisions about your credit card usage and, if necessary, consider alternative cards that better align with your preferences and goals.

Conclusion

Building credit with rewards credit cards is a smart and rewarding financial strategy. By choosing the right card, making on-time payments, and managing your credit responsibly, you can establish and improve your credit score while enjoying the benefits of cashback, points, or miles. Remember to stay informed about your credit, avoid common myths, and make the most of your rewards. With time and discipline, you can achieve a strong credit profile that opens doors to even better financial opportunities.

Please note that while using rewards credit cards can be beneficial, responsible credit management is essential to avoid debt and financial pitfalls. Always spend within your means and prioritize your financial well-being.

Disclaimer

The information provided in this guide is for educational purposes only and should not be considered financial advice. Building and managing credit responsibly is crucial for your financial well-being.