How maxing out your credit card affects your credit score
EVEN IF YOU PAY IT OFF EVERY MONTH
Mogo’s credit score expert, Chantel Chapman, explains how your level of indebtedness can affect your financial standing.
Welcome to our ongoing series on what impacts your credit score! Last week, we explored how missing even a $4 minimum payment can significantly lower your score.
Just in case you don’t know what a credit score is, let’s set the stage: a credit score is one of the main indicators of your financial health. It’s what lenders use to determine how big a mortgage or loan (or how high a credit card limit) to offer you and at what interest rate. Having a low score could result in getting approved at higher interest rates — or even being declined. And lenders are not the only ones checking credit; some landlords and employers do it as well.
IF YOUR CREDIT CARD LIMIT IS $10,000, DO NOT BORROW OVER $7,000
There are many factors that will impact how high or low your credit score is, but this week we are focusing on the second-largest factor and one that a majority of Canadians are not aware of: utilization ratio. This one tip I am about to teach you can improve your score in as few as 30 days.
Your utilization ratio is your level of indebtedness, or how much of your total available credit you’re using. For example, if your credit card limit is $1,000 and your balance is $1,000, your utilization ratio is 100 per cent — and this not good in the eyes of the credit bureau. Credit bureaus base credit scores on behaviour with credit. If you are constantly maxing out your credit cards, it could imply that you are not far away from defaulting on your minimum payments. It looks like your income is stretched.
There are two rules for utilization ratios. One rule is for those who pay off their balances in full every month, and the other is for the 46 per cent of Canadians who carry a monthly credit card balance.
Scenario 1: If you pay your balance off every month
Don’t ever let your utilization ratio go over 70 per cent. For example, if you have a small business and want to build up points, you may put all your expenses on your credit card every month. You pay this off at the end of every month, but your credit card company reports your balance to Equifax (the largest credit bureau in Canada) two days before you pay the balance off in full. When your score is calculated, it will show that you maxed out your card. I see this scenario with many successful business owners who don’t have the best credit scores for this very reason.
Tip: Set an imaginary limit of 70 per cent and do not go over that. Doing this will keep your credit score healthy. For example, if your credit card limit is $10,000, do not borrow over $7,000.
Scenario 2: You carry a balance on your credit card
If you tend to carry a balance on your credit card, try to keep it under 35 per cent. There are two reasons for this. First, this is close to the magic number for utilization ratio and contributes to a strong credit score. The other reason is that it helps you put a cap on racking up debt that might not be manageable. When a credit card company increases your limit, it is not necessarily looking at your entire personal budget and might not be aware that you can afford to spend the maximum and pay it off in a timely manner. You are responsible for setting these imaginary limits for yourself to stay in control.
Approximately 30 per cent of your credit score is made up of your utilization ratio. Fixing your utilization ratio is one of the fastest ways of improving your score, so if you have a habit of accumulating credit card debt, make a payment and yours core can increase quickly.
It’s important to know your credit score well in advance so that you are not surprised when you are shopping for credit. Ideally, you should also be aware of how it changes from month to month.
You can get your Equifax credit score at no charge with free monthly monitoring at mogo.ca. Checking your score with Mogo does not impact your credit score.