With the economy starting to open up again, it can be tempting to make up for lost time and splurge as much as possible. You may be tempted to treat yourself to new clothes, gadgets, furniture, and other shiny objects all at once. But this type of “revenge spending” can hurt your finances. Maxing out your credit cards by spending your entire card limit can have a negative impact on your overall financial health, especially your credit score.
Why? Because credit utilization is one of the most important factors that impacts your credit score. In fact, your credit utilization rate makes up 30% of your credit score. If your credit utilization rate is too high, your credit score could start dropping, and you might find it more difficult to qualify for financial products in the future. Not sure what any of this means? Don’t worry: we’ve got you covered below!
Credit utilization is the amount of credit you've used out of the total amount available to you. Specifically, it’s how much money you’ve spent using credit cards and lines of credit divided by the total credit limits on each of those accounts.
For any credit card or line of credit account you have open, you can calculate your credit utilization rate on it by dividing your total credit card debt by your total limit. For example, if the balance on your credit card is $500 and your credit limit is $1,000, then your credit utilization rate would be 50%.
For your overall credit utilization, you should add up all of your balances on credit cards and lines of credit, including home equity lines of credit, and divide them by the combined credit limit from each of your accounts. You can find your credit balances and credit limits by downloading your credit report. Once you’ve downloaded your credit report, you’ll find information about each of your credit accounts and can follow this quick 4-step process to calculate your credit utilization rate:
Your credit utilization rate is important because it’s one of the key factors that makes up your credit score. Your credit score is a three digit number between 300 and 900 that shows banks, lenders, and other companies how likely you are to pay back debts on time. The higher your score, the more likely these companies are to work with you.
A good credit score can help you qualify for credit cards, loans, and mortgages. A bad credit score could get you denied for these types of products. Because your credit utilization rate impacts your credit score, you want to make sure it’s at a good level. This is especially true if you’re thinking about making a big purchase, like a car or a home.
What’s the ideal credit utilization rate that you should have? The Financial Consumer Agency of Canada suggests that you use less than 35% of your available credit. Borrowell recommends keeping your credit utilization rate below 30% to reduce negative impacts to your credit score. This can help you demonstrate to banks, lenders, and other companies that you’re a financially responsible borrower that isn’t stretched thin financially.
A low credit utilization rate indicates that you have a strong grasp of your finances, while a high credit utilization rate might mean that you’re overextending yourself and could possibly indicate to lenders that you are having trouble managing your finances.
If you’re looking to buy a house or get a loan, you need to pay attention to how much of your available credit you’re using. With Borrowell, you can check your credit score for free and automatically have your credit utilization rate calculated for you.
The next time you think about maxing out your credit cards, remember the impact it can have on your credit utilization rate, your credit score, and your overall financial health.
