I was recently contacted by one of my good friends who was quite literally foaming at the mouth in anger.
One of the best thing about being a personal finance blogger is a year down the line people are choosing your blog posts for you!
To improve his credit score he had taken out a high interest credit card solely for the purpose of using during the month and paying off in full on payday.
Sounds about right you may think, but you’d be wrong.
Using your credit card in this way is likely to have a negative impact on your credit score, rather than the other way around.
I’m going to explain why.
Why does my credit limit affect my credit score?
It is not uncommon to receive an automatic increase in your credit limit from your credit card provider.
It can be confusing whether or not to accept it, as the last thing you want is for anything to affect your score adversely, especially if like me it took you years to finally get accepted for credit.
Similarly, it can be just as confusing as to whether or not you should lower a limit, or even get rid of a card that you just aren’t using very much anymore.
But why would any of this affect my credit score? – I hear you ask
Well, quite simply, your credit score is calculated in part based on how much available credit you have and how much is being used.
The easiest way to calculate exactly how much of your available credit is being used is to add up the total sum of everything you owe in credit, then divide that by the number of agreements you have.
The amount of debt you owe, which includes you debt usage – or debt utilization – as it is known, accounts for roughly 30% of your entire credit score.
Highly important as it is second only to paying on time, which equates to around about 35% of your credit score.
On that basis, increasing your credit limit can have a positive affect on your credit score, providing you do not increase your debt level because of it, resulting in lower debt utilization.
Generally speaking, the lower your balances compared to credit limit the better.
Credit experts recommend you keep your outstanding balances to a ration of 25% or less.
Or, in plain English, never use more than 25% of your available credit balance if you can help it – not always possible I know.
If you are trying to improve your score that amount drops to no more than 10% of your available balance.
If you’re concerned you may be using more than the optimal credit limit, speak to your provider about setting up text alerts, that way you stay in control.
Although we’ve established to maintain your score you should use no more than 25% of your available credit balance and no more than 10% of your available credit balance if you want to improve your score, you should still use at least one of your cards.
Having no activity at all makes it difficult to give any insights to your repayment habits.
You also run the risk of unused credit accounts being closed down, which would reduce your available credit limit and lower your credit age – another MAJOR credit scoring factor.
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