Credit cards make it convenient to shop, especially online. But it’s important to understand how these financial products affect your credit health. While everyone’s credit scores react differently, applying for a credit card, using a credit card, and making payments toward an outstanding balance all have the potential to affect your credit score.
Key Points
- A credit card can either positively or negatively affect your credit score, depending on how you use it.
- Your credit score may be positively impacted if you make bill payments on time and in full every month.
- Your credit score may be negatively affected if you are late on your bill payments or max out your credit card.
Does Applying For A Credit Card Affect Your Credit Score In Canada?
Yes, applying for a new credit card can impact your credit score in several ways, either negatively or positively:
Hard Inquiries
When you submit a credit card application, the card provider will likely perform a credit inquiry to check your credit score. This will be a hard inquiry of your credit, so it may have a negative impact on your score for a short time. Creditors need to check your credit score to get a sense of how likely you are to make timely bill payments before extending new credit to you.
Average Age Of Accounts
When you open a new credit card, the average age of your credit accounts will decrease. Most credit scoring models take into consideration the average age of your accounts when calculating credit scores.
In this scenario, having an older average age of credit accounts is ideal. However, adding a new credit account to the mix will decrease the average age of your credit accounts, which could impact your credit score.
Credit Utilization Ratio
Your credit utilization ratio is the difference between your available credit limit and the balance you carry, as mentioned. A lower credit utilization ratio may contribute to a healthier credit score.
Opening a new credit card can increase your available credit, which can decrease your credit utilization ratio if you don’t increase your spending. Ultimately, this may have a positive effect on some credit score calculations.
How Paying Off Your Credit Cards Can Impact Your Credit Score
Paying off your credit card bill on time each month is one of the best ways to work toward establishing healthy credit.
Positive Payment History
Consistently paying your credit card bill every month is an excellent way to build good credit. Again, timely bill payments contribute to good credit, so using your credit card to make your payments on time can go a long way at helping your credit score increase.
Lower Your Debt-To-Credit Ratio
If you pay your outstanding credit card balance in full every month, you’ll effectively bring your credit utilization ratio down to near zero. As mentioned, a lower credit utilization ratio is one of the ways to keep your credit score healthy. So, if possible, try to make more than the minimum credit card payments every month. And if possible, avoid carrying a balance over by paying in full.
What Happens When You Miss A Credit Card Payment?
Missing a credit card payment can result in expensive consequences:
- Late fees
- Increase in interest rate
- Negative effect on your credit score
At the very least, consider making the minimum payment to avoid these possible repercussions if you can’t afford to pay your bill in full. While this will mean an outstanding balance carried forward (which will incur interest), at least your payment will be considered on-time.
How To Control Credit Card Performance And Boost Your Credit Score
Credit scores are impacted differently depending on the scoring model used, so there is no one size fits all approach to improving or building your credit scores. That said, adopting healthy credit card habits, like the following, is always a good idea and may even help you improve your credit over time:
- Pay Your Bills When Due – Always pay your credit card bill on time. If you know your bill is extremely high for this month and you can’t afford to pay it in full, at the very least make the minimum payment. Late fees should be avoided at all costs – but be mindful of the minimum payment trap.
- Pay The Full Balance – While minimum credit card payments can be made to avoid late payments, paying the full balance by the due date helps keep your credit utilization ratio low.
- Avoid Maxing Out Your Credit Card(s) – Even if you can afford to pay off your full balance when it’s due, aim to keep your balance low. Spending no more than 30% of your available limit is a good rule of thumb.
What Determines A Credit Score?
Your credit score is calculated based on the information that appears on your credit report. This data is translated into a three-digit figure which lenders may refer to while making decisions. Here in Canada, credit scores range from 300 to 900.
Higher credit scores may indicate to potential lenders and creditors that you are more likely to make your payments on time and therefore may represent less risk as a borrower. But lower scores can indicate the opposite.
Factors That Determine Your Credit Score
There are five common factors used to calculate credit scores in Canada. Depending on the credit scoring model used, these factors and the weight put on them may vary.
Payment History (~35%)
How you manage your bill payments holds the most weight when it comes to your credit score calculation. A history of timely payments will have a positive effect on your credit score, while a string of late or missed payments can do the opposite.
Other specifics may also be considered, such as the frequency of on-time or late payments, how late any payments were, how much you owe, and whether any accounts are considered in default.
Credit Utilization Ratio (~30%)
Sometimes referred to as a debt-to-credit ratio, your credit utilization ratio refers to the amount you spend against your available credit. For instance, if you have a $10,000 credit limit on your credit card and you spend $2,500 against it, your credit utilization ratio would be 25% ($2,500 ÷ $10,000 x 100).
A credit utilization ratio of no more than 30% is generally considered acceptable and may be good for your credit score. Ratios exceeding this level can be bad for your credit score.
Length Of Credit History (~15%)
The age of your credit accounts will be considered when your credit score is calculated Generally speaking, older accounts will lengthen the average age of your credit accounts, which is a good thing for your credit score.
Public Records (~10%)
Public records, such as liens, consumer proposals, bankruptcies, and collections can negatively affect your credit score.
Credit Inquiries (~10%)
When a creditor or lender pulls your credit file, this is known as a “hard pull” or “hard inquiry”. These inquiries can have a negative effect on your credit score, especially if several are made in a short window of time.
Bottom Line
Credit cards can be a great financial tool for both convenience in spending and building healthy credit. However, if used irresponsibly, credit cards may have a negative impact on your credit. Keep an eye on how your credit card habits are affecting your credit score and make changes to your financial behaviors where necessary.
