by Scott Hannah
Q: My boyfriend and I have recently moved in together and we started talking about how to share the bills. He likes to pay for everything with his credit cards to get points, but he’s also mentioned that some months he has to decide between making all of his payments and buying groceries. I usually pay my bills with cash and only use my credit card for emergencies, so I could help him out by making payments to his cards for my portion of the bills. But in the long run, if he can’t get a grip on the way he spends with his credit cards, isn’t he going to ruin his credit rating? ~Valerie
A: Credit cards can be your friend or foe, but it all depends how you use them and your overall financial situation. Collecting points is one thing, but always charging your card up to the limit and not paying it off or down significantly, can ruin your credit rating. For someone who may need to borrow money to buy a car or home or consolidate debt, maintaining a positive credit rating is important. Conversely, someone who doesn’t plan to borrow in the next year or two, collecting the points might be more important.
However, life can throw us curve balls. To make sure we’re prepared for the unexpected, it’s wise to take steps to maintain a positive credit rating and avoid common credit card mistakes.
Here are five ways people damage their credit rating when using credit cards:
1. Paying Your Credit Card Off Too Soon
It’s true that using a credit card can help build up a credit rating. However, if you’ve dug yourself out of debt and are worried about getting back into trouble with credit cards, it can be tempting to pay them off as soon as you use them. That’s fine from a money management perspective but it won’t help you re-build your credit rating.
Your credit card must reflect activity and a balance owing, even a very small one, when your usage information is reported to the credit bureaus by the credit card company. Your payment information is then reported the following month and you begin to accumulate positive rather than no (or negative) information. If you use and pay your card all pretty much on the same day, that once-a-month snapshot report won’t reflect the activity. So while it's always good to pay off your credit card balance by the payment date so that you don't have to pay interest, you also don't want to regularly pay it off weeks before the payment date or your use of your card may not be reflected on your credit report.
2. Paying Credit Card Debt Off Too Slowly
Some people joke that they are their bank’s best customer because of all the interest and fees they pay. Despite what you may hear about lenders being happy that you’re "a great customer" (one who pays a lot of interest or fees), carrying balances for years at a time is bad for your credit rating. When you have debts that never get paid off, it can signal to lenders that you have more debt than you can afford to repay.
When this happens, lenders get nervous that you may default on what you owe them. A missed pay cheque, illness or injury could really make it hard to honour your obligations. The credit scoring system is designed to reflect such situations, so paying credit card debt off too slowly, or never, can lower your credit rating in the long run.
3. Closing an Account with a Balance Owing
If you are trying to pay your credit card off but keep getting tempted to use it, you might think of closing your credit card until it’s paid off. While this might seem like a good way to get your spending reigned in, when it comes to your credit rating, it’s not a wise idea.
The less you owe on your credit cards in relation to the limits, the better it is for your credit rating. When a credit card account is open, you have a limit and your balance owing is lower than that limit. However, when you close the account (or if it’s closed for you), the limit drops to zero, so any amount you owe is higher than the approved limit on the account. Being over the limit damages your credit rating.
If you want to stop yourself from spending impulsively with your credit card, "damage" the card yourself and tuck it away in a drawer. Once you’ve paid it off, if you want to use it again, call and have your damaged card replaced.
4. Keeping a Credit Card for Emergencies
Many people view their unused credit cards as a safety net; if something happens, they can pay for it with an unused card. When you rely on a credit card to get you by in a pinch, if it’s a card you don’t normally use, it may not be there when you need it most.
Unused accounts are a liability, both for the card holder and the credit card company. If someone with bad intentions were to get hold of this unused card’s account number and details, they could ring up quite a bill. With unused cards, you typically don’t get a bill each month because there isn’t any activity to report, so it could be a number of months before you notice the fraudulent activity.
If it’s an account you didn’t even call to activate, leaving the sticker on the front for just in case, the credit card company will likely close the account for you after a period of time. Activating proves that you received the card, so not activating a card makes it a big unknown and open to risk.
A much wiser strategy is to work on beefing up your emergency savings. That way you have cash on hand to get by during an emergency, and you won’t face a bill once you’re back on your feet. If you do want to set one card aside for just-in-case, use it to pay for one small item each month so that it has regular activity that triggers a bill.
5. Making Late Payments
Routinely making late credit card payments is a bigger deal than most people realize. Not only are you signaling that you have a potential money management problem, you are not living up to your contractual obligation.
Late credit card payments mean a lot of things to lenders, the most serious of which are that you have an income problem, e.g. you earn less than you did before, and that you have too much credit available to you. The credit rating system is set up to recognize these factors, so late payments on credit cards sink your rating quickly.
Income and current available credit are two of several important considerations when a lender evaluates a new credit application, e.g. if you are applying for a loan. Late payments show that you are a risky person to lend money to. And with higher risk come higher interest rates and more restrictive or expensive terms and conditions.
If you've gone down this path, get out of the habit of paying your credit cards and other bills late. To get ahead of the payments, create a budget and then a pay cheque plan. Decide ahead of time when each bill will be paid. Mark it on your calendar or set up recurring payments through your online banking. If you need help getting on track, you can meet with a non-profit Credit Counsellor to review your budget and provide you with helpful suggestions and guidance (they are usually happy to help for free or at a very low cost).
The Bottom Line on Not Damaging Your Credit Rating
When your goal is to get your credit rating on track, it will take some time, but all of the little things you do will add up to make a positive impact. There’s no such thing as a quick fix credit repair program; practice sound money skills as you manage day to day, improve your level of financial literacy, and learn about credit reporting in Canada. You’ll then be poised to use your credit cards as the tools they were designed to be.