Have you ever heard of the butterfly effect? It’s a theory based on the idea that even the smallest action – like the flapping of a butterfly’s wings – can somehow affect a larger event, like the weather.
Similarly, when it comes to your money habits, small decisions you make in the past may have a big impact on your credit score - the three-digit number between 300 and 900 that lenders check to help decide how likely you are to repay your debts.
The bottom line is if you really want to improve your credit score, you should avoid making these common mistakes.
- Paying the monthly minimum
Your credit card is maxed out, but everything’s okay because you’re making the minimum monthly payments, right? Wrong. You’re just treading water here (and paying a lot in interest) – and while there may be no late payment charges, you could be hurting your credit score and your chances of getting more credit in the future. The more of your credit limit you use, the worse it is for your credit score. When you pay the monthly minimum and continue to make purchases on your card, you’re keeping your credit balance high and that lowers your score.
Your credit history and how you make payments affects your credit score and where you lie on the credit score range. It’s important to get out of debt and paying more than the minimum payment is one great way to get there.
- Making late payments
Life gets busy and sometimes we can forget to make payments on time, or we might pay one bill a little late because another unexpected expense comes up. But all late payments are noted – even if only a day. The news only gets worse the longer it takes to for you to make payment. If a creditor sends your file to collections, improving your credit score will be more difficult.
Always make your payments on time – on or before the due date.
- Having multiple credit cards
It’s so easy – some would say too easy – to get credit in Canada. Sometimes cards just show up in the mail like magic (and always at a time when you’re strapped for cash!). Some come with bonus gifts just for signing up.
But it’s not magic. And taking on that added (and unnecessary) responsibility only makes it harder for you to pay more than the monthly minimum for each card on time. Because it’s not the number of cards that lowers your score necessarily, it’s how you manage multiple cards that matters. Before you know it, your credit score range can dip from average to poor.
You can build up your score by using and paying off one credit card.
- Spending to your credit limit
Part of your credit score is determined by how much credit you use compared to how much credit you have available. Maxing out your credit card lowers your score because lenders tend to think higher debt amounts are more difficult to repay. Your credit score is affected by your “credit card utilization ratio” – how much of your available credit you’re using. Divide your balance by your credit limit and then multiply by 100. A card that has a $1,000 limit and has a $300 balance gives a 30% credit card utilization ratio. Experts say about 30% or lower is ideal.
- Applying for credit too often
Most experts agree two credit cards should be the maximum because more credit cards mean more temptation. Also, applying for several credit cards in a short period hurts your score because each application counts as a “hard inquiry” from a lender checking your credit. Your score loses points for multiple hard inquiries because lenders tend to see that as a sign you’re short on cash or are planning to take on a lot of debt.
Keeping an extra, unused credit card in case of an emergency might seem like a good idea, but a much better idea would be to start a savings account and add to it on a regular basis.
Actions that seem small can have big effects down the road. If you avoid these mistakes, you are well on your way to actually improving your credit score!
Interview with Stacy Yanchuk Oleksy, Credit Counselling Society
Interview with John Lawford, PIAC
Interview with Scott Hannah, Credit Counselling Society
(all interviews by Tom, 2018)