Credit cards are how most young Canadians first learn about financial responsibility, building healthy or unhealthy financial habits, and their credit scores. While credit cards can help you purchase expensive items and make online purchases a breeze, they are also one of the best ways to build a credit history and credit scores.
While everyone’s credit scores react differently, applying for a credit card, using a credit card, and making payments toward a credit card balance, all have the potential to affect your credit scores.
What Determines A Credit Score?
Your credit scores are calculated through the analysis of the data that appears on your credit report. The 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.
The two credit bureaus in Canada (TransUnion and Equifax) use five different factors to determine your credit score:
- History of payment ~35%
- Outstanding debt ~30%
- Length Of Credit History ~15%
- Public Records ~10%
- Inquires ~10%
Does Applying For A New Credit Card Affect Your Credit Scores?
Yes, applying for a new credit card can impact your credit scores in several ways. But, as we explain above, all credit scores react differently so applying for a new credit card may impact your credit scores more or less than another consumer.
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 to make sure that you are creditworthy before expending 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 is ideal. Because of this, it’s possible that opening a new credit card and decreasing your average age could impact your credit scores.
Your credit utilization ratio is the difference between your available credit limit and the balance you carry. A lower credit utilization ratio every month may contribute to healthier credit scores. If you’re looking to improve your credit and max out your credit card every month, you may want to consider using a smaller amount of your credit limit.
So how does taking out a new credit card affect your credit utilization? Opening a new credit card will increase your available credit limit which can decrease your utilization ratio if you don’t increase your spending. Ultimately, this may have a positive effect on some credit scores.
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 scores. Consumers who are trying to build a credit history or improve their credit should always make their payments on time.
What Happens When You Miss A Payment?
When you miss a payment, lenders and creditors will likely report the payment as missed 30 days after the due date. Because your history of payments is one of the major factors that affect the calculation of your credit scores, having a missed payment on your credit report could negatively affect your credit scores. How late your payment is as well as how many late payments you’ve made will also contribute to the calculation of your credit scores.
This is why always making your payments on time is so important.
Other Consequences Of Late Payments
When you miss a credit card payment, there may be additional consequences from your credit card provider. You may incur a late fee and of course, you’re charged interest on your balance that is not paid off.
If you’re frequently late on your payments, your credit card provider may also decide to increase your interest rate.
How To Control Credit Card Performance And Boost Credit Scores
All credit scores are impacted differently so there is no one size fits all approach to improving or building your credit scores. But, adopting healthy credit card habits is always a good idea and may even help you improve your credit over time.
- Pay Off Balance When Due – Always, no matter what, 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 please mindful of the minimum payment trap.
- 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, around 30% of your available limit is a good rule of thumb.
- Consider Making Payments Twice A Month – If you like to use your credit card to accumulate points or cash back rewards but also want to keep your balance low, consider paying off your credit card twice a month.
Credit cards can be a great financial tool and if used properly they can and will help you build a healthy credit history, but if used irresponsibly they may have a negative impact on your credit. Keep an eye on how your credit card habits are affecting your credit by monitoring your report and credit scores on a monthly basis.