The holidays are here, and it is time to buy presents. For many people, the need to treat friends and family to great gifts at Christmas time leads to a bad financial decision: piling presents on a credit card. When you max out your credit cards buying Christmas presents, not only do you end up having to pay off those gifts well into the new year, but you can also do damage to your credit score that can cost you over the long term.
Maxing Out your Credit Card Is a Bad Idea
Maxing out your credit card at Christmas time- or any time, for that matter- will impact your credit utilization rating. Credit utilization is one factor that affects your credit score, and it accounts for as much as 30 percent of your score under popular credit scoring formulas pioneered by the Fair Isaac Corporation (FICO scores).
Credit utilization refers to the amount of your available credit that you use. It compares your total debt with the total credit that you have available. For instance, if you have a credit card that has a $1000 limit on it and you charge $500 on that credit card, you will have a credit utilization ratio of 50 percent ($500/$1000).
The higher your credit utilization ratio, the more dangerous of a risk you appear to creditors to be. High credit utilization indicates an over-reliance on credit and a possible inability to pay your bills, should something happen that causes your income to go down.
Most experts recommend that you keep this credit utilization ratio at around 30 percent or less in order to have the best possible credit score. Maxing out your cards is going to bring your score down since you will exceed this 30 percent limit.
What to Do If Your Cards Are Already Maxed Out?
If your credit cards are already maxed out or your credit utilization is above your 30 percent limit, you have a few options for what you can do. The most obvious option is to pay down your debt, but this can be a challenge, especially around the holidays when you have a lot of expenses coming your way.
Another option might be to increase the amount of credit you have available to you. You should NOT do this by opening up new credit cards. Opening up new cards lowers your credit score, both because it reduces the average age of your credit (a longer average age is better) and because it results in an inquiry showing up on your credit report (too many inquiries sends up red flags to lenders).
Until you can lower your credit utilization, it can make sense to delay major purchase of a house or a car. As you get further away from the holidays and you can reduce your credit utilization, these actions could raise your credit score, which can save you money in the long-term on big purchases.