In this article, we will discuss the topic of credit utilization and how it affects your credit score. We will explain the concept of credit utilization and how it impacts your credit rating, and we will provide some tips for effectively managing your credit utilization rate.
What is Credit Utilization?
Credit utilization is the ratio of your credit card balances to your credit limits. This rate measures the amount of available credit you are using. For example, if your balance is $300 and your credit limit is $1000, your credit utilization rate for that card is 30%. If you add $500 of new charges to your card each month and your credit limit is $1000, you will have a utilization rate of 50%.
How Does Credit Utilization Affect Your Credit Score?
Credit scoring models like the FICO model look at your credit utilization from two angles. First, they assess the utilization for each credit card separately. Then, they calculate your overall credit utilization, which is the total balance of all your credit cards compared to your total credit limits. High credit utilization in either category can negatively impact your credit score.
Why is High Credit Utilization Bad?
The purpose of a credit score is to assess the likelihood of repaying borrowed money. Certain factors make it more likely for people to fail to meet their credit obligations. One of those factors is having high balances on credit cards and loans.
Tips for Managing Your Credit Utilization Rate
To manage your credit utilization, especially if you are using your credit cards heavily, you can follow some simple steps:
Spread Charges Across Different Cards
This way, you will have lower balances on multiple cards instead of having one card with over 30% of your limit utilized. However, you should remember that some credit scoring models also look at your overall utilization, so this method may not always work.
Time Your Payments Correctly
Know when your card issuer reports information to credit bureaus and pay attention to your card’s payment date each month. If your balance is high when your card issuer sends your account information to credit bureaus, like a few days before the end of the billing cycle, your credit utilization rate used in your credit score will also be high.
Request a Credit Limit Increase
If you have a card with a limit of $5000 and you have spent $2500, your utilization rate is 50%. You can call your card issuer and request an increase in your credit limit to $25000, for example, if you have had a change in income. This change in credit limit could reduce your utilization rate to just 10%, which can significantly affect your credit score. However, credit bureaus can also lower your credit limit if you have some late payments or a high utilization rate. So you should consider your circumstances before requesting a credit limit increase.
Pay Your Credit Card Bills Twice a Month
This is one of the most effective ways to keep your credit utilization low. This way, even if you use your cards throughout the month, you can make a mid-month payment to reduce the card balance to a level that remains below the allowable percentage (30%).
It’s good to know that high credit utilization will not affect your credit score forever. Once you reduce your credit card balances or increase your credit limits, your credit utilization rate will drop, and your credit score will rise.
Questions
Frequently Asked Questions (FAQs)
What is a good credit utilization ratio?
Generally, it is recommended to keep your credit utilization ratio below 30%, and the lower the ratio, the better. A utilization ratio of 1% is better than 0%. In other words, if you stop using a certain card, do not close the account, as this reduces the overall amount of available credit.
How can I improve my credit score?
To improve your credit score, you will need to address any issues affecting your score. You can start by reviewing your credit reports and ensuring there are no errors. If you find any errors, report them to the credit bureau that issued the report. Next, make sure you are current on your payments and continue to pay your cards on time. Finally, consider your credit utilization after you have been current on all your minimum payments.
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Source: https://www.thebalancemoney.com/understanding-credit-utilization-960451
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