If you have a credit card, chances are you know that there are 5 major factors that play into your credit score. Payment history at 35%, credit utilization at 30%, age of credit at 15%, credit mix with 10% and inquires also at 10%. However, the one most consumers remain confused about is credit utilization. Credit utilization has the second largest impact on your score, but what is credit utilization and how can I get the highest score possible with it?
What is credit utilization?
Credit utilization is the amount you spend on your card vs. the limit that the credit card carries. It is essentially a measurement of how much of your credit you have used.
For example, you have a credit card with a $1,000 limit and your balance is $200, then your credit utilization is 20% (Take your credit card balance and divide it by your credit limit: $200/$1,000= .2 X 100 = 20%). Overall, the lower your credit utilization, the better off you’ll be. Using low amounts of credit shows lenders that you are responsible.
But how does utilization affect my score?
Typically, most credit card companies will send monthly reports to the 3 credit bureaus (Equifax, Experian, and TransUnion). These reports may not line up with your balance due dates, so in some cases, your utilization may be high due to the reporting dates. This can easily be fixed by placing a call to your credit card company and double checking when the reports are sent out to the bureaus. 30% of your FICO-based credit score is affected by credit utilization, so it’s important to be vigilant about your spending habits.
What’s so bad about high credit card utilization?
The entire goal of a credit score is to give potential lenders an opportunity to see how likely you are to repay your balances. One red flag for many creditors and lenders is high credit card balances. Typically, having a high balance sends a red flag to creditors that you may be relying on credit to get by. This increased risk will mean that you might get stuck with a high-interest credit card.
Be proactive and check your account balance to be certain of the billing days. In some cases, you may get your credit limit reduced. If this happens, be sure to match your utilization rate to your new credit limit. The typical consensus is that you should utilize only 30% of your available credit.
There is no way to trick the FICO model by paying off your balance entirely at the end of each billing cycle. All of this depends on when your credit card company sends its reports to the 3 credit bureaus.
However, if you want to reduce your credit utilization, you can always ask for an increase on your credit limits. This will help reduce your utilization ratio and help increase your score.
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