Interest-free loan: how is "utilisation" calculated re credit score?

Question

I have, historically, always had an excellent credit score. I never spend beyond my means, and always pay off my credit card in full every month. I really only have the credit card in order to accrue the points & benefits given by the provider.

Last year I bought a new TV. There was a "buy now, pay later" offer at 0%. Effectively an interest-free loan. Although I could have dipped into may savings and paid for the TV outright in cash (and indeed would have done had it not been for the offer) - I've always been attracted to interest-free credit, because as long as I maintain the instalments I have nothing to lose. And since the instalments are paid by direct debit, there's no chance I will forget to make a payment.

If I wanted to, I could pay off the balance in full and clear the credit account at any time. I have the cash. It would just mean less money in my savings account, and therefore less interest earned for me.

However, since opening this interest-free credit account, I noticed that my credit score has decreased from "excellent" to "moderate/good". This is the only change in financial circumstance, and I'm sure it can not be caused by anything else. All other payments (credit card, mortgage) are up to date.

How exactly does the interest-free purchase affect my score? I'm aware that with credit cards, there's a "utilisation" calculation in that if you consistently have a high balance relative to the amount available to spend, the utilisation goes up (and the score goes down). But with the interest-free loan, there's no utilisation per se.

Should I expect my credit score to recover slowly as the instalments are paid, and the outstanding balance decreases?

Answer 1

However, since opening this interest-free credit account, I noticed that my credit score has decreased from "excellent" to "moderate/good". This is the only change in financial circumstance, and I'm sure it can not be caused by anything else. All other payments (credit card, mortgage) are up to date.

Taking the above statement as true.

How exactly does the interest-free purchase affect my score? I'm aware that with credit cards, there's a "utilisation" calculation in that if you consistently have a high balance relative to the amount available to spend, the utilisation goes up (and the score goes down). But with the interest-free loan, there's no utilisation per se.

Lets say you went wild and spent $2500 on a TV. That is a loan for $2500 being paid for over months or years. That $2500 is $2500 of utilization. You opened a line of credit and then applied $2500 in charges against that line of credit.

The store did that to entice you to spend again. If you were unlucky regarding your credit score the line of credit was only slightly larger than the cost of the TV. That means that the utilization of that account is high.

for example:

         Typical monthly balance    Max Credit   Utilization 
Before:         $1,000               $7,000      14%
New:            $2,500               $3,000      83%
After:          $3,500              $10,000      35%

Your after utilization is more troublesome to potential lenders, and is reflected in your lower score.

Should I expect my credit score to recover slowly as the installments are paid, and the outstanding balance decreases?

Yes. As the months go by the loan will decrease and the utilization will improve.