Credit card utilization – everything to know
Have you checked your credit card utilization lately? It’s one of the biggest factors that affect your credit score, so you must know how it works. This will allow you to keep it at a level that maintains your good credit score. This is important to have nowadays, especially because of the uncertainty we face nowadays.
Fortunately, you can maintain good credit card utilization by using your lines of credit in a certain way. For example, it goes up and down depending on how many products and services you put on your plastic swiper. You may even ask your credit card issuer to make some adjustments to your card. We’ll talk more about them later.
Let’s start by talking about what credit card utilization is and how it affects your overall credit rating. Then, we will go through the ways of maintaining your utilization at optimal levels. The goal of doing this is to get a good credit rating, and utilization is just one of the factors to it. That’s why we will talk briefly about the other factors in your credit score.
What is credit card utilization?
Whenever you use your credit card, banks take note of your balances. At certain times in the year, they submit the latest data to the credit bureaus.
They are in charge of assessing all those records to assign credit scores to cardholders. These ratings help banks see if borrowers are likely to repay their debts or not.
Banks are lenders since they let people defer payments for goods and services. It’s only natural that they would want people to pay them back.
That rating comes from five factors based on the FICO credit scoring model. We will focus on one of the biggest ones called credit utilization.
It’s the ratio between a person’s credit balances and their total credit limit. Specifically, it covers a specific type of credit called “revolving credit.”
Notice how you can just rack up debt on your credit cards? That’s the type of credit line included in utilization. Home equity lines of credit (HELOCs) also count as revolving credit.
Most people hold credit cards though, so we often talk about credit card utilization. For these plastic swipers, it’s the ratio between the credit card balance and their card limits.
Let’s say someone’s card has a $5,000 balance and a limit of $10,000. If we divide $5,000 by $10,000, then multiply it by 100, we’ll get a percentage of 50%.
The current FICO model says a good credit utilization ratio is 30% and below. The person in our example yielded a 50%, so their utilization is in trouble.
This will likely reduce their credit rating because this factor makes up 30% of it. Fortunately, there are ways to get this 30% rating.
Read More: What Are The Advantages Of Good Credit?
How do I maintain good credit card utilization?
We’ve seen that this factor has two parts: the total balance and limit. If we want a lower ratio, we may either reduce the balance or increase the limit.
Let’s say the person from our example paid off $2,000, so the balance goes down to $3,000. If we divide it with the $10,000, their card now has a 30% credit utilization rate.
On the other hand, we may raise the credit limit. Instead of taking off $2,000 from the balance, let’s add $7,000 to the credit card limit. It goes up from $10,000 to $17,000.
If we divide 5,000 with $17,000, then multiply it by 100, then the credit card utilization becomes 29.4%. As a result, it’s now at a good level!
These are just some examples of how you can maintain a good utilization rate. But how do you do this in real life? Read the following tips below:
- Reduce your debt – Similar to our example, you may simply pay your unpaid balances. Even if you can’t pull them to zero yet, what matters is that you’re reducing that unpaid amount. This may still give you a lower credit card utilization rate.
- Pay twice a month – You must pay your credit card monthly. If you have extra cash though, you might want to put in more payments. That way, you may drag down your unpaid balance faster, so you can get that 30% utilization rate sooner.
- Request for higher limit – Your card issuer may give you a higher credit limit. Reach out to your bank to see if it will allow this.
- Keep old credit cards – If you’re thinking of closing some credit card accounts, don’t. This will lower your total card limit and increase the utilization rate.
- Apply for a business credit card – if you have a business, you may use a separate credit card for it, so its expenses won’t factor into your utilization rate. Check your card if it allows this though, as others may not provide this feature.
- Get a new credit card – A new credit card adds to your total credit card limit. However, you will have to be careful as other factors affect your score. For example, you will have a free credit score inquiry each time you apply for a card. Sadly, this action also lowers your credit rating.
Other credit score factors
Banks often follow the FICO score model, and credit utilization is just one of its five factors. The following list shows all these factors and provides more details:
- Payment history (35%) – This is the biggest factor because it considers your on-time and late payments. Build a record of on-time payments, and lenders will see that you’re likely to repay them. Otherwise, they might keep you from getting the best terms or outright decline your credit applications.
- Credit utilization (30%) – This is one’s the focus of this article, and it’s the second-largest factor that affects your credit score. As we said, it only covers revolving credit, unlike others like student loans.
- Credit history (15%) – Do you recall my advice about keeping your old credit cards? That’s because your old lines of credit make up your credit history. The longer you hold on to them, the higher this factor will be. However, you have to use them sometimes because it also considers how long since you’ve used these accounts.
- Credit mix (10%) – This refers to the types of credit you have. It increases as you hold more because it shows lenders that you can handle debt properly. Still, you have to make sure you pay each one on time.
- New credit (10%) – You’ll notice that this scoring model rewards having various kinds of credit, so it’s no surprise that it encourages opening new ones. As I said, you should be careful when doing this because your credit provider will often perform a hard credit check that lowers credit scores.
Other ways to improve credit rating
You see that other things affect your rating. This means that you have even more ways to get a higher credit score. Let’s look at some of them below:
- Debt payoff – Your number one way of raising your credit score is by paying your debts on time. This improves your payment history, which is the biggest factor in your score.
- Balance transfer credit cards – You may combine all your credit card debt into a new card that has a lower interest rate. What’s more, balance transfer cards usually have a 0% interest period that lasts around 6 months. This lets you reduce your debt without interest in the way, so you can pay them off much quicker.
- Consolidation – Similar to how balance transfer cards work, you may mix all your loans into one that charges lower interest. For example, you may do this with student loans.
- Settlement – Some companies may negotiate with your lender to lower your unpaid balances. This may fail though, so it’s best to use debt settlement as a last resort.
Credit card utilization is just one factor that affects your credit rating. You will have to improve the others too, such as payment history, by paying on time.
Personal finance management is more about discipline than method. In other words, the debt reduction methods won’t work without your effort and hard work.
If you’re having trouble doing this yourself, you can get a financial advisor to help you. You don’t have to spend too, because you may choose from several nonprofit groups.