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When you carry a balance on your credit cards that isn’t paid off each month, you are accumulating interest on those purchases on your credit card, most people know that. What I am going to share with you now, most people don’t know about using their credit cards. How you use your credit cards, affects your credit score and your credit rating, more than just if you get them paid off or if you don’t.
A combination of different factors are used to create your credit score which is what potential creditors and lenders look at to decide whether to lend money to you or not and at what interest rate. It is a number between 0-780+ that is equated to how “risky” you are to give a loan to, the higher risk you are determined, then the higher the interest rate that you will pay or the harder that it will be to secure credit. If you have a higher score, then they equate that as you are a “lower risk.”
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The difference between someone who has a really good credit score and a poor credit score over the course of a lifetime, can be $100,000 difference, which is why I want to educate you more on credit scores, why you should care about them and what you can do to improve them, so you can pay less money in interest when you borrow money for a home, vehicle, etc.
There are many factors that affect your credit rating, but for now, I am going to share just one of them, that is the one you most likely have never heard about. This is your debt to credit ratio. This means the ratio of how much credit you have available to you compared to how much you are using. It is better to have a low debt to credit ratio. So what this really means, is how much credit you have available ex: a $5000 credit card and then how much you are using on it. Many people I know, use their credit cards for everything, because they are collecting points or perks to work towards getting a free trip, etc. That is great, when you are being very strategic about how you are using your cards.
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Your credit score is not just affected by if you get your credit cards paid off each month. It’s not black and white, you get a gold star because you paid your credit cards off this month and you get a red x because you didn’t get your paid off. There is a lot more that goes into it than that. Which is why you would probably be surprised to find out, that even if you are getting your credit cards paid off every single month, that the way that you are using your credit cards, can still be affecting your credit score, even though you are “doing everything right.”
This is where the debt to credit ratio comes into play
Just because you have a balance of $5000 on your credit card and you pay it off every single month, does not mean that using that full amount all of the time, doesn’t have its cons as well. The debt to credit ratio is in reference to how much you have available and how much you are using. Now you would naturally think, that if you are paying your credit cards off in full and not exceeding your balance, that you would be getting gold stars all around. Now from a lender’s standpoint, if you have a credit card with a limit of $5000 and you are consistently using most of that amount, because you need to or because you put everything on it so you can earn rewards, it appears like you may have problems with managing your finances and that you need that credit in order to get by. It appears that you have a higher chance of missing your payments and like you are a higher risk to be lending money to.
Now there is some information when it comes to credit scores where it gets blurry, because it does have its own algorithm and like FB and IG, they don’t tell you exactly how that algorithm works.
But, it is suggested, to aim for about a 20-30% utilization ratio on your credit cards
Ex: If you have an $8000 credit card limit and you spend $6500 on it, even though yes you have spent within your allotted amount and even if you do pay it in time, it can affect your credit rating negatively because your ratio is over the optimal 20-30%. So I suggest trying to stay below 30% as often as you can.
Want a free e-book to walk you through the 4 Steps to Get Your Credit Cards Paid Off? Click here to download my free e-book.
Click here to download my Realistic Budget template!
My tips for you to help improve your credit card habits and usage so it helps you to improve your credit score:
If you spend more than this 30% a month, to pay your credit cards off more often than just once a month, so the amount is not building up, it shows as a smaller number and therefore helps to keep your debt ratio lower. You could pay it off weekly, bi-weekly or even more often.
$3000 credit card x 30% (0.3) = Aim to have lower than $900 of purchases on your card at all times, even if you are paying it off in full each month.
It is okay to use your debit card for purchases and to pay for it that day, if you struggle with spending outside of your means, I encourage you to use your debit card more often because you think differently about your purchases when it is more in real time, because the money is coming right out of your account at that very moment and not two weeks or a month from now.
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I encourage you to make your finances a priority to right now, to get your finances organized and an action plan going forward. To make the commitment to speed up your credit card monthly payments and to get your credit cards paid off so much faster. This will help to improve your credit score and help you to pay less interest now and in the future, which like I said, that interest adds up to much more than most people would ever imagine. The difference between someone with a poor credit score and a really good one, can be the difference of $100,000 in interest over a lifetime.
I helped one of my client to be able to reduce her monthly expenses in areas that she didn’t even know she was spending money in and other areas that she knew she needed to cut back on but didn’t know how! This made it so she could put more towards her credit card, so she now almost has her $7000 credit card paid off from what she has implemented from working with me, versus before she had that credit card balance for years and wasn’t able to get it paid down on her own.
Click here to download my Realistic Budget template!
Frequently Asked Questions about Financial Coaching
If you want some more tips for getting your debt paid off quicker, download my free “4 Steps to Pay Off Your Credit Card Debt” E-book, this gives you the step by step actions to take, to get your debt paid off much quicker than you currently are right now.
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Do you have any questions? Leave me a comment and I will respond back to you!
