The holiday season is quickly approaching, and you might be planning out what gifts to buy for your loved ones. Who knows, maybe you’ve already started!
With the economy slowly re-opening from the pandemic, you may be enticed to embark on a good ol’ fashioned shopping spree. If you’re shopping around, make sure to support small businesses when you can! You should also make sure, however, that you aren’t stretching yourself too thin financially.
You might be tempted to splurge out, buy an excessive amount of gifts for friends and family (and maybe yourself) to make up for lost time. Try to avoid this. Why? Because this type of spending, known as “revenge spending” can hurt your long-term financial health. Specifically, pushing your credit cards to their limits can bring down your credit score.
How Does Excessive Credit Card Spending Hurt Your Credit Score?
Spending an excessive amount with your credit card will increase your credit utilization rate. Put simply, your credit utilization rate is your total credit card debt versus your total credit limit. You can calculate your credit utilization rate by adding up your balances on your credit cards and dividing your total balance by the combined credit limits from each of your cards.
Here’s a quick example. If you have one credit card with a balance of $5,000 and your credit limit on that card is $10,000, then your credit utilization rate would end up being 50%.
Your credit utilization rate is the second largest factor that impacts your credit score. If your credit utilization rate is too high, your credit score could start to decrease. When this happens, you may find it tricky to get approved for financial products in the future.
Where Can You Find Your Credit Utilization Rate?
To calculate your credit utilization rate, you should add up all of your balances on credit cards and lines of credit and divide them by the combined credit limit from each of your accounts. You can find your credit balances and credit limits by downloading your credit report.
In your credit report, you’ll find information about each of your credit accounts and can follow this quick 4-step process to calculate your credit utilization rate:
- Add up your balances from all your credit cards and lines of credit
- Add up the credit limits from all your cards and lines of credit
- Divide the total balance from Step 1 by the total credit limit from Step 2
- Multiply by 100 to get your credit utilization rate as a percentage
What’s The Recommended Credit Utilization Rate To Have?
30% is the magic number you should aim for when it comes to your credit utilization rate. Keeping your credit utilization rate at 30% or below shows lenders and other companies that you’re a responsible spender and borrower who isn’t stretched thin.
Low credit utilization shows that you have a hold of your finances, while high credit utilization might signal that you have issues with overspending or managing your money.
Excessive credit card spending can easily push your credit utilization rate above 30% and put a dent in your credit score. In the example above, spending $5,000 out of a credit limit of $10,000 already puts your credit utilization rate at 50%, above the recommended rate of 30%.
How Can You Reduce Your Credit Utilization Rate?
Here are some of the top tips you can use to help reduce your credit utilization rate and improve your credit score in the long-term.
1. Reduce current credit card balances: The most obvious method is to pay off your current credit balances. You don’t have to pay them off completely; just try paying off enough of your balance to reduce your credit utilization ratio to 30% or below.
To calculate how much you need to lower your credit balance by, multiply your total credit limit by 0.30 and look at the difference between that figure and your current revolving balance.
In the earlier example, multiplying your $10,000 credit limit by 0.30 gives you $3,000. Subtracting $5,000 (your balance) by $3,000 gives you $2,000. This means you would need to pay off $2,000 of your total credit balance to reach an ideal credit utilization rate.
2. Use debit in the short-term: Consider paying expenses with your debit card instead of credit cards. Using debit to pay expenses can help you lower your credit card balances and reduce your credit utilization.
3. Increase your credit limit on existing accounts: Increasing your credit limit can actually have a positive impact on your credit score. If you increase your credit limit and keep your spending the same, your credit utilization rate will decrease.
Contact your current lenders and ask for a credit limit increase. Your lender may approve your request if you have a solid payment history with them. If you’re able to increase your credit limit, resist the urge to spend more; the purpose of increasing your credit limit is to decrease your credit utilization rate, not spend more excessively!
4. Open another credit card or line of credit: Opening another credit account can also help you increase your credit limit. Open a credit card and make a small purchase, like a coffee, once a month to keep the account open. Be disciplined about the new amount of credit available to you, and resist the temptation to splurge more!
5. Transfer credit card debt into a debt consolidation loan: A debt consolidation loan can help you combine multiple sources of debt into one manageable payment. Transferring your credit card debts into one loan will lower your credit utilization because loans are considered installment credit, which aren’t included in credit utilization calculations.
Spend Responsibly This Holiday Season
Treating yourself and your loved ones to new toys and gadgets can feel rewarding, especially after the last few years we’ve had. Just don’t overdo it! Remember that “revenge spending” this holiday season can impact your credit score, your long-term financial health, and your chances of reaching future financial goals, like buying a car or a house.
So the next time you’re shopping during a Black Friday or Boxing Day sale, remember the impact that excessive credit card spending can have on your credit score and your overall financial health.