From that scary moment when your housing association needs your social security number to when you’re applying for a mortgage, we all know your credit score is important. For better or for worse, it tracks your use of credit and gives lenders (and landlords) an idea about how you handle debt.
And while some of the criteria for establishing a good credit score might seem arbitrary, it’s important to know what goes into your score so that you can have the best one possible.
And that brings us to your credit utilization. While less known and understood than such factors as whether you pay your bills on time, credit utilization accounts for up to 30% of your FICO score. So it’s important. But what exactly is credit utilization?
Also known as your debt-to-credit ratio, it is the ratio of your overall outstanding balance to your overall credit card limit. To put it into numbers, if you’ve got a $5,000 limit across your credit cards and your total balances are $500, then your credit utilization percentage is 10% ($500 / $5,000). It’s important to note that this only considers credit card and other revolving debts, not installment loans such as student loans or mortgages.
Credit Utilization 101
A ‘Good’ Credit Utilization
A ‘good’ credit utilization ratio is considered to be less than 30%. Keep in mind, however, that 30% is not a magic number, and lower utilization ratios can improve your score and help build it.
Per Card Vs. Overall Credit Utilization
Credit scoring models consider both overall credit utilization and per card credit utilization. Per card credit utilization is calculated in the same way as noted above. Experian describes a consumer’s per card debt-to-credit ratio as important, but doesn’t provide details on just how important. Still, as you work to lower your credit utilization, focus on both your overall and per card usage.
Credit Utilization Matters Differently Based on Your Credit Profile
For those who’ve had a good credit scores for many years, one month with a 32% credit utilization rate is unlikely to impact you overall score that much. It might make your score dip for a bit, but theoretically it should bounce back soon after.
However, if you have just started establishing your credit, it could have a different effect on your credit. The key here is to understand that changes in a credit file can affect individuals differently based on a number of factors, some of which FICO doesn’t disclose.
Credit Utilization Matters Even If You Pay Your Cards in Full Each Month
If you pay your bill on time every month, you might think you’d have a 0% credit utilization. Not true. The amount owed is based on what your credit card issuers report to each credit agency. It’s extremely unlike that your credit card issuer will send this data on a day when your balance is $0.
According to the Fair Isaac Corporation:
Your account balance on your credit report will reflect the account balance your lender reported to the credit bureau (typically the balance from your latest monthly statement). So even if you pay your credit card balances in full each month, your account balance won’t necessarily show on your credit report as $0.
Thus, if you are working hard to raise your score, it’s best to keep your credit utilization as low as possible throughout the month.
4 Tips to Lower Your Credit Utilization
If it’s a struggle for you to keep your ratio below 30%, here are some easy ways to not let your credit utilization rate sink your credit score.
1. Ask for a Higher Credit Limit
If you’re consistently edging into a 30% utilization and are paying off your bills each month in full, consider asking for a higher monthly balance. According to FICO, people with exceptional credit scores routinely use around 7% of their overall credit. That doesn’t mean that only using 7% of your credit will earn you an 800 score, but it does show you that a low credit utilization rate is one of the factors associated with a good score overall.
2. Set Up an Automatic Balance Alert
Since some agencies score each card for its utilization as well as your overall credit utilization, set a balance alert on all your credit cards for whatever 29% (or a lower amount) of your credit line is. That way you’ll never accidentally go over your credit utilization goal on one card.
3. Pay Your Bill Twice Monthly
If you’ve got a big expenditure, and you know you’re going to go over 30%, you could pay down your balance twice that month. This may help you keep your credit utilization as low as possible. This isn’t necessarily a good tactic to use every month but can help in a pinch. The Apple Card* will have this feature built into the app Apple plans to launch later this year.
4. Be Careful About Closing Accounts
This advice doesn’t apply to the average consumer. But for those of you in the credit card rewards game (which you should be) it’s important to remember that closing an account will result in less overall credit. While this seems obvious, it’s important to take that into account when thinking about your overall credit utilization ratio.
For travel hackers, signing up for a card for its sign up bonus and then cancelling that account a year later when the annual fee kicks in, can be a good way to snag free flights. However, if you do this too much or forget about your overall credit utilization ratio, you could end up negatively affecting your credit score. For example, if you cancel a card but forget that that means your overall limit is $1,000 less, you could end up hitting a higher credit utilization ratio by accident. Cancelling cards can also reduce the overall “average age” of your accounts, which can also negatively affect your score.
On the flip side, a still active credit account that you don’t actually use can boost your score. So make sure before cancelling an account that it won’t significantly hurt your overall credit utilization ratio. Coughing up an annual fee might be more cost effective, long term, than damaging your credit score, particularly if some big purchase—say a home–is on the horizon. (You can read more about how your credit score affects your mortgage rate here.)
