CHECK YOUR FREE CREDIT SCORE

How Overspending Can Affect Your Credit Score

06-Mar-2019 written by : FSI-Team

Can Affect Your Credit Score

If you want personal loans and home loans at the best interest rates and through an easy process, then your credit score should be excellent. However, there are various things that can hurt your score too, one of which is poor credit management or overspending. But how does that work exactly? Let’s find out.


What is Overspending?

Overspending, by definition, is “spending more than available”. However, when we consider the context of the cibil score and money management, then overspending means maintaining a high credit utilization ratio when using credit cards.

To take an example, let’s say that you have two credit cards A and B, and the limit on A is Rs. 50,000 and that one B is Rs. 1 lakh. You can calculate your overall utilization by using this formula:

Credit utilization ratio = (Total balances on all credit cards / Total of credit limits on all cards) X 100

Let’s say your average monthly spending with A is Rs. 20,000 and that on card B is Rs. 50,000. So, the utilization would be:

(20,000+50,000)/(50,000+1,00,000) = 70,000/1,50,000= 0.46 = 46%

How Does Credit Utilization Affect Credit Score?

When your credit utilization is high, then it can have an adverse effect on your credit score. This is because it shows that you are not managing your money properly and depending on credit a lot. Most lenders associate this habit with risky users who may easily end up finding their name on loan defaulter list.

In the example above, the utilization ratio was 46% which is quite high. An ideal ratio is no more than 35%. In other words, if you want to improve your score, then you should take measures to bring your utilization ratio down. Some of these include:

Lowering Expenditure

Once your expenses are lowered, your credit utilization lowers on its own. You will be surprised to see how many of your purchases are luxuries and things that you don’t even require. So, try to create a monthly budget and separate your “wants” from your “needs”. Your credit score is really important and you should take every step in your capacity to protect it. Besides splurging your money is never good.

Using Cash More Often

If you have a habit of using a credit card for every other purchase, then it’s important that try to control your urges and use other payment methods such as debit cards, mobile wallets, and even cash. Increasing your credit card balance on a consistent basis is an easy way to ruin your cibil score. So, the sooner you improve your spending habits, the better.

Obtaining Another Credit Card

If for any reason you have to use credit cards a lot, then you can consider getting another credit card to lower the burden. To understand how this works, let’s go back to the above example. In this, you had two cards A and B with limits of Rs. 50,000 and Rs. 1 lakh and your total monthly expenditure was Rs. 70,000. Now, let’s assume that you got another credit card C with a limit of Rs. 1 lakh. Let’s calculate the utilization ratio again:

(20,000+50,000)/(50,000+1,00,000+1,00,000) = 70,000/2,50,000= 0.28 = 28%

As you can see, just adding another credit card to the process dropped your utilization ratio to just 28% which is a lot better than the previous 46%.

Use Apps

High credit utilization isn’t always your fault as you can sometimes just forget that you have reached 30% or 35% mark. To avoid this from happening, install your bank’s credit card app that can provide you with analytics and credit card balance monitoring tools. You may even get to set up alerts that can notify you when your utilization ratio reaches a certain level.

Bottom Line

Overspending is one of the worst habits that you can develop for your credit health and personal wealth. If you are already repaying a loan, then this habit can also put your name on a loan defaulter list which is the last thing you want on your credit report. So, make sure that you take control of your spending habits as soon as possible. The tips above can also help you a lot. Good luck!


AROUND THE WORLD

STAY CONNECTED!

Don't miss a bit of Credit News
Join the FSI Force