Why Does Using Your Credit Card Hurt Your Credit?
Learn how your credit card habits, from spending to account management, directly influence your credit score and financial standing.
A credit score is a numerical representation, typically ranging from 300 to 850, that assesses an individual’s credit risk and their likelihood of repaying debts on time. This three-digit number plays a significant role in personal finance, influencing whether you qualify for various financial products such as credit cards, auto loans, and mortgages. It also affects the interest rates and other terms associated with these credit offerings. While credit cards can be powerful financial tools for building a positive credit history, the way they are managed profoundly impacts overall credit health.
High Credit Utilization
Credit utilization refers to the ratio of your outstanding credit card balances to your total available credit. It is calculated by dividing the total debt across your revolving credit accounts by the sum of your credit limits on those accounts, expressed as a percentage. For instance, if you have a total credit limit of $10,000 across all your cards and a combined balance of $3,000, your credit utilization is 30%. This ratio is a significant factor in credit scoring models, accounting for approximately 30% of your FICO score and being highly influential for VantageScore.
A high credit utilization ratio can negatively impact your credit score because it suggests to lenders that you are heavily reliant on credit or may be experiencing financial distress. Lenders may perceive individuals who use a large portion of their available credit as a higher risk, potentially indicating an inability to manage debt effectively. For example, carrying a $900 balance on a $1,000 credit limit card (90% utilization) signals greater risk than a $100 balance on the same card (10% utilization).
Financial experts generally recommend keeping your overall credit utilization ratio below 30% to maintain a healthy credit score. Some with excellent credit scores maintain utilization rates in the single digits, often below 10%. It is important to note that even if you pay your balance in full each month, a high utilization can still be reported to credit bureaus if your balance is elevated on the statement closing date. To manage this, paying down balances before the statement closing date can help ensure a lower utilization ratio is reported, even if you plan to pay the full amount shortly after.
Late or Missed Payments
Payment history is widely considered the most significant factor in credit scoring models, holding the largest weight in determining your credit score. When you make a late or missed payment on a credit card, it indicates a failure to meet financial obligations, which is a major concern for lenders. Even a single late payment can significantly lower a credit score, particularly for individuals who previously had good or excellent credit.
The severity of the impact depends on how late the payment is. While a payment that is only a few days past its due date might incur a late fee, it generally will not be reported to the credit bureaus. However, payments that are 30 days or more past due are typically reported and can cause a substantial drop in your score. A 60-day or 90-day delinquency will have an even more severe and lasting negative effect.
A reported late payment can remain on your credit report for up to seven years from the original delinquency date. While its impact on your score tends to diminish over time, especially if you establish a pattern of on-time payments afterward, the record itself persists. Consistently paying at least the minimum amount due on time, every time, is therefore crucial for maintaining a positive credit history and a healthy credit score.
New Credit Card Applications and Account Closures
Applying for new credit cards can affect your credit score due to what is known as a “hard inquiry.” When you formally apply for new credit, the lender typically performs a hard inquiry on your credit report to assess your creditworthiness. This type of inquiry can temporarily lower your credit score by a few points.
The impact of a hard inquiry is usually minor and temporary, with the score drop often being less than five points for most individuals. Hard inquiries remain on your credit report for up to two years, but they typically only affect your credit score for about 12 months. Multiple hard inquiries within a short period, especially for credit cards, can be viewed as an increased risk by lenders, signaling potential financial distress or an attempt to take on too much new debt.
Conversely, closing an old credit card account can also negatively impact your credit score. This action can reduce your total available credit, which may increase your credit utilization ratio on your remaining cards. For example, if you close a card with a $5,000 limit and maintain a $1,000 balance on another card with a $2,000 limit, your utilization jumps from 14% (1000/7000) to 50% (1000/2000). Closing an account also shortens the average age of your credit accounts, which is a factor in credit scoring models, accounting for 15-21% of your score. A longer credit history generally contributes positively to your score. Exercise caution before closing older credit card accounts, especially those without annual fees, to avoid negative consequences on your credit score.