Here is a simple way to think of your credit cards and catalogue accounts using the traffic light colours. It can give a warning signal where you may have problems in the future.
First you need to compare the balance you owe at the moment to your credit limit. Your limit is shown on your credit card statement.
Say you currently owe £1,000 and your limit is £4,000 – in this case you are using 25%.
But with a lower limit of £1,500, the same balance of £1,000 would be using 80% of your limit.
This is called your utilisation. When your credit score is calculated, a low utilisation helps your credit score and a very high one harms it.
The idea is that if you have a lot of spare credit then you probably aren’t in financial problems at the moment.
You will also be better placed to cope with an unexpected bill in the future. Having unused credit gives you options.
Red – Amber – Green
The traffic light coding then works like this:
- RED if you are using over 90%. This is the danger zone. You need to stop using the card and start paying it off.
- AMBER if your balance is between 30% and 90%. That’s a wide range – obviously if you are nearer to the 90% point you may have problems sooner, but if you are down close to the 30% level it’s much safer.
- GREEN if your balance is under 30%.
Why those numbers?
Those numbers come from Experian who use these ranges in calculating your credit score.
- if your card balance is over 90%, 50 points is taken off your credit score, even if you are making all the repayments on time.
- if your balance is under 30%, your score is booted by 90 points. (You can get an even bigger boost – an extra 60 points – if you have a zero balance.)
Credit score calculations are complicated so if you have two cards you can’t just add up those numbers.
But these give you a feel for the impact on your credit rating – you can find out more guidelines here: How much will my Credit Score change if…?
The other warning signal – minimum payments
How much of your credit limit you are using isn’t the only thing that matters. Another warning signal is if you are only paying the minimum to a card or a catalogue.
People like credit cards because they are flexible and you don’t have to pay the same every month.
It’s fine to pay the minimum in December when you have a lot of other expenses, or if you have just paid a big bill from the garage for your car. It’s also fine to pay the minimum to a “cheapish” credit card while you are paying off more expensive debt.
But if you have been paying the minimum for months and you think it would be difficult to pay more, then this is “the minimum payment trap”.
It takes a very long while – often 15 or more years – to clear a credit card if you only pay the minimum each month. There are millions of accounts in this situation.
Luckily there is a way out of this trap if you can stop using the card. You need to fix your monthly payments at their current level. This small change will make a huge difference.
Can’t stop using your cards?
Getting your balance down on a card isn’t going to work unless you stop using it or cut it right back. If you don’t think you can manage this, talk to a good debt adviser.
You may not think your problem is that bad, but if your card balance carries on going up the minimum amount increases. In a few months or a year, you will be in a much worse position.
Here are some good places to get debt help, depending on where you live, if you are self-employed, etc. Debt advisers like speaking to people early on, before a crisis has happened, so don’t worry that you will be wasting their time.