5 ways credit cards reduce your credit score

When used wisely, credit cards can help build a strong credit history and improve credit scores. As a result, it’s easier to get a loan.

However, using credit cards for everyday and non-essential spending can lead to spiralling debt. This negatively impacts your credit score. Because of this, it will be harder to access credit.

For some people, credit cards are best avoided. However, having credit history is an important factor to lenders when they are making lending decisions. This is because they need proof that an individual is able to repay a loan. Mobile phone contracts can help. However, on their own, they do not boost credit scores enough. To get higher value loans, you’ll definitely need more credit history.

Credit cards can be incredibly beneficial to improve credit scores. This is particularly useful if you want to achieve milestones, including getting a mortgage.

However when mismanaged, credit cards can have a negative impact.

Here are some common ways credit cards can negatively impact your credit score and how to avoid them.

Maintaining a high balance

Having a high balance on your credit card, especially if it exceeds 75% of your credit limit, can significantly harm your credit score. This is because credit utilisation, the amount you owe compared to your credit limit, is a major factor in determining your credit score.

Avoiding a high balance

Aim to keep your credit utilisation low. If possible, pay off your balance in full each month. If you can’t pay the full balance, at least pay more than the minimum amount due. Consider requesting a higher credit limit, but only if you can trust yourself not to increase your spending. As a first step, getting the balance to below 25% of the limit is a great start. For example if you have a limit of £500, this would mean ensuring the balance was under £125.

Going over your credit limit

Exceeding your credit limit can result in penalties and fees. Importantly, it suggests to lenders that you may be struggling to manage your credit effectively. This behaviour can lower your credit score.

Keeping within your limit.

Monitor your credit card usage regularly and set up alerts to notify you when you are approaching your limit. Practising disciplined spending and budgeting can stop you going over your limit.

Withdrawing cash from a credit card

Using your credit card to withdraw cash is often seen as a sign of financial distress. Cash withdrawal typically comes with high fees and interest rates that start accruing immediately, unlike purchases which may have a grace period.

Don’t withdraw cash

Avoid using your credit card for cash withdrawals unless it is an absolute emergency. If you find yourself needing cash frequently, consider reviewing your budget to understand where your money is going. Explore other options like an overdraft. Try the 50/30/20 budgeting rule.

Reaching your credit limit quickly

Quickly reaching your credit card limit is also known as ‘credit velocity.’ It can indicate risky financial behaviour to lenders. This is because credit cards are an expensive way to borrow. Quickly maxing out a card might show you’re desperate for credit or living beyond your means. Maxing a credit card, especially if done within a few months, can negatively impact your credit score. Consequently future credit may be more expensive or harder to obtain.

Spend slowly

Spread out your spending over time rather than using up your credit limit in a short period. Plan major purchases in advance and ensure you have a strategy to pay them off without quickly reaching your limit.

Applying for multiple credit cards

Each time you apply for credit, a hard search is made on your credit report. Multiple applications in a short period can suggest to lenders that you are desperate for credit or unable to manage your finances. This can lower your credit score.

Apply less often

Think carefully when applying for new credit. Space out your applications over time. Only apply for credit when you truly need it. Before applying, check your eligibility using a soft credit check.

A credit union alternative?

By avoiding these common credit card traps, you can maintain a healthy credit score and improve your chances of being accepted for future credit. Responsible credit card use involves monitoring your spending, keeping balances low, and being strategic about credit applications. By following these practices, you’ll be on your way to a stronger financial future.

If you feel less confident about managing credit cards, you can consider a credit union loan. By repaying a loan you will improve your credit score in the longer-term. In fact a credit union loan can complement a credit card as a way to improve your credit score.

But remember – when you take out a loan your credit score will decline because of the hard credit check and the period between when the loan is outstanding and starts to get repaid. It can take around three months before improvements are seen.