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How Can your Budget Impact your Credit Score?

 Published on May 26, 2023

How Can your Budget Impact your Credit Score?

Maintaining a good credit score is essential for a healthy financial life. It can impact your ability to qualify for loans, credit cards, and even housing. Your credit score is calculated based on a range of factors, including your payment history, the amount of debt you owe, the length of your credit history, and more. However, many people don't realize that their budget can also have a significant impact on their credit score.

Your budget is a critical aspect of your financial health. It’s a plan for how you spend and save your money, and in the end, these things can affect your credit score in Canada. Here's how your budget can impact your Canadian credit score and what you can do to help make sure that your budget is working in your favor.

1. Late Payments

One of the most significant factors in your credit score is your payment history. Your credit score is impacted by how timely you make your payments. If you’re late on a payment, it can have a negative impact on your credit score. This impact can last a while, as late payments can stay on your credit report for years.

Calendar open to month of january.

Your budget plays a crucial role in organizing your finances and ensuring that you make your payments on time. When you create your budget, you should include all your bills and payments, including your credit card payments, loan payments, and utility bills. This will help you prioritize your expenses and ensure that you have enough money to cover all your payments on time.

2. Debt-to-Income Ratio

Your debt-to-income ratio is another critical factor that lenders look at to determine your creditworthiness. Your debt-to-income ratio is the amount of debt you have compared to your income. Lenders use this ratio to determine your ability to repay your debts. The higher your debt-to-income ratio, the riskier you are as a borrower.

Your budget plays a crucial role in managing your debt-to-income ratio. When you create your budget, you should include all your debts, including your credit card balances, personal loans, and other outstanding debts. This will help you determine your total debt and your debt-to-income ratio and assess which areas need improvement.

Ideally, you should aim to keep your debt-to-income ratio below 42%. This means that your debt should not exceed 42% of your income. However, the lower you can keep it, the better. If your debt-to-income ratio is too high, it may be more challenging to qualify for certain loans and credit cards. You can improve your debt-to-income ratio by paying off your debts and increasing your income.

3. Credit Utilization

Credit utilization is another essential factor in your credit score. Your credit utilization is the amount of credit you are using compared to your credit limit. The higher your credit utilization, the riskier you may seem as a borrower. High credit utilization can indicate that you’re relying too heavily on credit and may not be able to pay it back.

Your budget plays a crucial role in managing your credit utilization. When you create your budget, you should include your credit card balances and your credit limits. This will help you determine your credit utilization so you can continue to monitor it and see where you can make changes.

Ideally, you should aim to keep your credit utilization below 30%. This means that you should not use more than 30% of your credit limit. If your credit utilization is too high, you can improve it by paying off your credit card balances or increasing your credit limits.

4. Length of Credit History

The length of your credit history is another factor used to determine your credit score. The longer your credit history, the more information lenders have to evaluate your creditworthiness. Your credit history includes the length of time you have had credit accounts open and the age of your oldest account.

Your budget can impact the length of your credit history by providing you with visibility into which accounts have been opened the longest. When you create your budget, you should consider keeping your oldest credit accounts open, even if you’re not using them and as long as you’re not paying excessive fees on them. This will help to increase the length of your credit history and impact your credit score.

How to Use your Budget to Potentially Impact your Credit Score

If your budget is impacting your Canadian credit score negatively, there are several things you can do that could help turn things around. Here are some tips:

  1. Create a budget - If you don't already have a budget, create one. A budget will help you to prioritize your expenses and ensure that you have enough money to cover all your payments on time.
  2. Reduce your expenses - If your budget is too tight, look for ways to reduce your expenses. This could include cutting back on discretionary spending or finding ways to reduce your fixed expenses.
  3. Increase your income - If you need to be bringing more money in, look for ways to increase your income. This could include taking on a side job, asking for a raise, or finding a higher-paying job.
  4. Pay off debt - If you have high levels of debt, look for ways to pay it off. This could include using the debt snowball or debt avalanche method or seeking help from a credit counseling agency.
  5. Monitor your credit report - Make sure to monitor your credit report regularly to ensure that there are no errors or inaccuracies that are impacting your credit score.

How to Create a Budget

Creating a budget is an essential step in managing your finances effectively. A budget can help you prioritize your expenses, track your spending, and ensure that you have enough money to cover your bills and save for your financial goals. Here are some steps to help you create a budget.

Person looking at their budget.

1. Calculate your Income

The first step in creating a budget is to calculate your income. This includes all sources of income, like your salary, bonuses, and any side jobs you may have. If you have irregular income, like freelance work, it's important to estimate your average monthly income.

2. List your Expenses

The next step is to list all your expenses. Start with your fixed expenses, like rent, mortgage, and car payments. These are expenses that will typically be the same each month. Then list your variable expenses, like groceries, utilities, and entertainment. These are expenses that can vary from month to month.

3. Categorize your Expenses

Once you’ve listed all your expenses, categorize them into essential and non-essential expenses. Essential expenses are those that you need to pay to maintain your basic needs, like food, housing, and transportation. Non-essential expenses are those that are nice to have, but not necessary, like eating out or going to the movies.

4. Determine your Priorities

After categorizing your expenses, it's time to determine your priorities. Focus on your essential expenses first and make sure that you have enough money to cover them. Then, prioritize your non-essential expenses based on your financial goals. For example, if you’re saving for a down payment on a house, you may want to reduce your entertainment expenses to free up more money for savings.

5. Set Limits

Once you’ve determined your priorities, set limits on your spending in each category. This will help you stay within your budget and avoid overspending. Be realistic with your limits and make sure that they align with your financial goals.

6. Track your Spending

The final step in creating a budget is to track your spending. This will help you see where your money is going and make adjustments to your budget as needed. There are many tools available to help you track your spending, like budgeting apps or spreadsheets.

Person using a calculator.

By calculating your income, listing your expenses, categorizing your expenses, determining your priorities, setting limits, and tracking your spending, you can create a budget that works for you and helps you achieve your financial goals. Remember to review your budget regularly and make adjustments as needed to ensure that you’re staying on track.

Pay Close Attention to your Budget

In the end, your budget can have a significant impact on your entire financial outlook, which ultimately affects your credit score. By creating a budget, prioritizing your expenses, and managing your debt, you may be able to impact your credit score and maintain good financial health. Remember to monitor your credit report regularly and take steps to implement healthy financial habits if necessary.

Disclaimer: This page provides general information only and does not constitute financial, legal or other professional advice. For full details, see Fora’s Terms of Use.