Here’s What You Need to Know About Credit Utilization

Credit scoring is a mystery to many people, and for good reason. It’s not easy to understand the grading process or which factors matter most.

Credit scoring is a mystery to many people, and for good reason. It’s not easy to understand the grading process or which factors matter most.

While every lender has its own method for deciding which customers are worthy of financial trust, more than 90% of top U.S. businesses rely on the FICO score when reviewing credit and loan applications, according to the company. Of course, you have more than one FICO score, so you might be feeling confused all over again, but here’s the good news: When it comes to credit health, it’s best to narrow your focus to five main factors:

  • Credit length
  • Payment history
  • Account diversity
  • Inquiries
  • Credit utilization

Why Is Credit Utilization So Important?

Every factor of credit scoring is crucial, but credit utilization is responsible for 30% of your overall score, second only to your payment history’s weight of 35%. Credit utilization measures your revolving balances against your total credit limit. Lenders and credit card issuers rely on credit utilization to predict risk and future behavior. In general, the higher your utilization ratio, the greater your risk of defaulting on your balances. Risky behavior isn’t rewarded in the world of credit scoring, and you may see a decrease in your scores as your utilization ratio goes up.

To understand credit utilization, you first need to understand your line-item and aggregate calculations.

Line-Item Utilization

Line-item utilization measures your individual credit card balances against your individual limits. For example, suppose you have three credit cards, each with a $10,000 limit. Based on your current balances, your line-item utilizations break down like this:

Card A: Balance of $4,500 / Credit limit of $10,000 = 0.45 × 100 = 45% utilization

Card B: Balance of $2,000 / Credit limit of $10,000 = 0.20 × 100 = 20% utilization

Card C: Balance of $3,300 / Credit limit of $10,000 = 0.33 × 100 = 33% utilization

Aggregate Utilization

The average of your credit card utilizations is called aggregate utilization. Calculate yours by combining your current balances and dividing them by your total credit limit. In the example above, your total balance is $9,800 and your total limit is $30,000; therefore, your aggregate credit utilization is $9,800 / $30,000 = 0.32 × 100 = 32.6%

Which One Matters?

Line-item and aggregate utilization are both important factors in overall credit health, and FICO recommends keeping yours as low as possible.

How to Benefit from Credit Utilization

Credit utilization has an undeniable affect on your credit score, and there are ways to harness its influence in your favor. (Not sure where your credit stands? You can view two of your scores for free on Credit.com.)

Keep Your Balances Low

If you struggle to curb spending or rely on credit cards to make ends meet, overhauling your budget is the first step. A few monthly changes could help you avoid overwhelming debt and related credit damage.

Check Your Credit Reports for Accuracy

Your credit reports tell the larger story of your financial history and responsibility, and accuracy is key. For example, suppose Card A’s $10,000 credit limit is mistakenly listed as $6,500 on your credit reports. While it may seem like a small issue, an incorrect credit limit can alter your utilization ratio and damage your credit score in the process. In this case, your line-item utilization would increase from 45% to 69.2%, and your aggregate utilization would increase from 32.6% to 37%. You can’t afford to ignore the details. Order free copies of your credit reports to ensure that they accurately reflect your credit card balances and limits.

Request a Limit Increase

If you’re working on debt reduction but need a quick fix, consider asking your lenders for limit increases on each of your cards. For example, increasing Card B’s limit to $15,000 would lower your line-item utilization from 20% to 13.3%, and your aggregate ratio from 32.6% to 28%. Requesting a limit increase could place a hard inquiry on your credit file, costing your score a few points, but the benefits of lower credit utilization are usually worth the temporary ding.

Change Your Bills’ Due Dates

It’s difficult to benefit from credit utilization if you are constantly battling the clock. If your credit card issuers report customer balances to the credit bureaus before you pay your bill, it may seem like your utilization ratio is constantly high. The fix? Contact your issuers and ask them when they typically report to the credit bureaus, and then move your bill’s due date to the week before. This strategy allows you to take full advantage of low credit utilization by giving you time to pay your balances before the reporting date.

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This Is the Single Best Thing You Can Do for Your Credit Score

Are your credit scores stuck, even though you do most of the obvious things right? You pay your bills on time (payment history accounts for 35% of your scores), you don’t often open new accounts (inquiries make up 10% of your scores) and you’re not recovering from a bankruptcy or default. Yet you still struggle to get your credit scores into prime range.

“There is no magic bullet for credit scores. You’ll have to shoot twice,” said Rod Griffin, director of Public Education at Experian. “First, pay on time, every single time. The second bullet is utilization.”

Your credit utilization, and taking steps to lower it, could be the key to better credit scores. (If you’re curious about how you’re doing, you can view two of your credit scores, updated every 14 days, for free on Credit.com.)

What Is Credit Utilization?

Utilization is the amount of debt you have in relation to your total credit limit. So, for example, if you have one credit card with a $1,000 limit and your balance is $500, your utilization is 50%. Credit experts recommend keeping your credit utilization at 30%, ideally 10%, of your total credit limit. (More on that later.)

In most cases, only revolving debts — not debts paid in installments, like mortgages and auto loans — contribute to your utilization ratio. (Find out more about revolving debt here.)

The reason revolving debt counts against your score is that can indicate risk. The credit industry tends to assume consumers who use a higher percentage of their open credit are more likely to fall behind financially.

“A higher utilization rate means a higher risk, which has a greater impact on your credit scores,” Griffin said.

Why Does Credit Utilization Matter?

Credit utilization is a critical element of credit scores, and credit scores lead directly to credit opportunities. Consumers with lower scores won’t qualify for the best credit products available. The credit products that are available to people with lower scores generally have higher interest rates, lower limits and fewer benefits.

“Credit scoring doesn’t look at money. Income and assets, odd as it sounds, have no bearing on whether or not you’ll pay your bills on time. Credit scoring shows the likelihood that the person will pay the debt back as agreed,” Griffin said.

Because of this, it can be very tough to achieve a top credit score if your utilization is very high, even if your debt is low.

How to Lower Utilization & Still Use Your Credit Cards

If you use credit cards, find out when your issuer reports your utilization ration and make sure you pay your balance off beforehand. It can sometimes be before your payment is due each month.

“If you don’t pay before the date the bank reports the information to the credit bureaus, you’ll show a balance,” Griffin said.

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My Credit Card Company Is Canceling my Account. What Can I Do?

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Q: Got a letter that one of my credit cards will be closed due to inactivity. I shouldn’t let that happen, right?

A: There are a lot of reasons you may not want to close a credit card, even if you’re not using it very often. But before we get into that, let’s talk about if and how you can stop a credit card company from closing your account.

What You Can Do If Your Bank Wants to Close Your Card

There are several reasons a creditor may want to close your card account — inactivity, fraud and default, to name a few — and every financial institution will have its own policies for handling those situations. If your bank sent you a notice about the account closure, check it for information on how to stop it. For example, it may say that using the card before a certain date will prevent it from being closed due to inactivity. Beyond that, call your bank for answers.

“Certainly people should contact the card issuer if they object to the account being closed,” said Nessa Feddis, senior vice president & deputy chief counsel for the American Bankers Association. “The bank may keep it open if it is appropriate.”

In the end, it’s up to the bank, and keeping your account active and in good standing can help you avoid an unwanted closure.

“There is no requirement to provide advance notice,” Feddis said. “Otherwise, for example, someone who no longer has the ability to repay would be tempted to use the entire line before the account was closed and then be unable to repay.”

How Closing a Credit Card Can Affect Your Credit

There are two main ways closing a credit card can hurt your credit. First, closing a credit card can hurt your credit utilization rate, and second, it could hurt your credit age. (You can read more here about how your credit score is calculated.)

Here’s an example of how it could affect your credit utilization: Say you have two credit cards, each with a $1,000 limit (meaning your overall available credit is $2,000). You only spend about $500 on one of the cards and pay off the balance each month, but you never use the other one. You want to use as little of your available credit as possible, both on individual cards and as a whole, but your overall credit utilization is most important for your credit score.

With both cards open and that $500 balance, you have a credit utilization rate of 25%. That’s pretty good — credit scoring companies recommend you keep your overall credit utilization rate below 30% or, ideally, below 10%. But because you’re not using that other card, the issuer decides to close it. You’re still using about $500 of that other credit limit every month, but now your overall available credit is only $1,000. That turns out to be a 50% credit utilization rate, and the increase from a 25% utilization rate to a 50% utilization rate can hurt your credit score.

The other thing to think about is your credit age: It’s calculated by averaging the age of your open accounts. The older your average credit age is, the better it is for your credit score. So if your credit card is on the older side of your credit history, it’s helping keep your average credit age up (because it can go down every time you open a new account). Take that old credit card out of the equation, and you may see your credit card suffer until enough time has passed for your active accounts to bring up the average age of your credit accounts.

Of course, there are good reasons for closing a credit card. Perhaps you really dislike working with the issuer, you’ve run into too much trouble with credit card spending or the card carries an annual fee that’s not worth it (if so, see if you can get it waived). Whatever you decide, it’s important to know how it will affect you. You can see how your credit cards and other accounts factor into your credit scores by getting your free credit report summary, updated every 14 days, on Credit.com.

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The Credit Mistake You Can Fix in 30 Days

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Trying to find a quick fix for bad credit isn’t easy, because for the most part, the things that go into a good credit score take a while to develop. In the most common credit scoring models, payment history has the most impact on your score, and that takes at least six months to establish. Recovering from a late payment requires even more patience. Once there’s a late payment in your credit report, all you can really do is give it time to reduce its weight on your credit score — there’s nothing you can do going forward that will make it “go away.”

But the next most important aspect of credit scoring works a bit differently. It’s called credit utilization, and that’s a measurement of your credit card balances relative to your overall credit limit. Using less than 30% of your available credit can help your credit score, and the lower your utilization rate, the higher your score will likely be. Perhaps one of the most important things to know about credit utilization is how quickly you can change it, consequently changing your credit score.

That can be a bad thing, because running up big credit card balance can quickly tank your score. At the same time, if you can quickly pay down high credit card balances, you could see serious score improvement in a short period of time.

Keep in mind you probably won’t know exactly when your credit card issuers will report your balances to the three major credit reporting agencies, so you may not see the credit scoring effect of paying off high balances right away. Issuers tend to report account activity on a monthly basis, so you’d likely see a change within a month of reducing your credit utilization.

You may want to quickly improve your credit scores for many reasons, like wanting to buy a car, take out a home loan or any number of life situations in which credit scores are a factor. If you don’t have the means to significantly reduce your credit card debt, you could consider consolidating it with a personal loan (though you’d have to weigh that against the potential negative consequences of taking out a new loan). However you want to approach improving your score, you’ll need to see how your plan is working. You can keep tabs on that by getting two free credit scores every 30 days on Credit.com.

More on Credit Reports & Credit Scores:

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My Credit Score Dropped 24 Points After Planning a Bachelorette Party

I’ve planned four bachelorette parties in the past five years (and attended five, including my own). I have the planning part down to a science. But this time around I had a little surprise — my credit score dropped 24 points when I checked it on my way home Sunday night.

Now, I should preface this with saying that the damage is temporary. It’s not fair to say the bachelorette party “wrecked my credit” since I’ve already remedied the cause of the credit score drop — my high credit utilization this month (more on how I fixed my credit later).

In my experience, planning bachelorette parties takes a lot of coordination, a lot of ridiculous party store supplies and a lot of PayPal/Venmo/Chase QuickPay account transfers. Most of the parties have been short weekend trips for groups ranging from six to 11 people, so it boils down to a few major expenses: house rental, transportation, an activity and a dinner out. The other things you end up buying— wine tastings, drinks at bars, lunches and breakfasts — tend to get paid for individually, without a joint tab.

The major expenses often require a point person, though — one credit card to rule them all. Even when you find a great house that can accommodate everyone at a very reasonable price, someone has to pull the trigger and put it on their credit card to reserve the space and, when you’re the one (or two) planning the trip, it tends to be you. Then, you collect the money from the other attendees and pay off your credit card immediately.

I’ve never minded doing this. After all, I write for a credit website, I’m very mindful of my credit, monitor my accounts daily, check my credit scores every month, and am constantly thinking about managing my money. For some people, this would be an understandable burden. After all, a house that can accommodate 11 women for a weekend isn’t cheap. If you’re already struggling to pay your balance in full every month with just your normal spending, it may not be the best move. After all, you could be short and then face interest charges.

The Hidden Benefit of Bachelorette Party Planning

There is a notable upside to putting all that spending on your credit cards and then immediately paying them off, though— the rewards. I made $500 off my credit cards last year and paid no interest charges or annual fees. This year, I’ve already made roughly $150, so I’m on pace to beat last year’s total. If you’re using the right credit card, you can really rake in the rewards on the group expenses of a bachelorette party. For example, I used my Chase Sapphire card (read a full review here) and got double points on our group’s lunch bill this weekend.

At the end of the weekend, I simply tallied up all the group expenses and gave everyone a per-person total they owed me. Everyone transferred me the money that day, easy breezy.

Why My Score Dropped 24 Points

So why did my credit score drop so much, exactly?

I had charged enough on my credit cards that I had a 20% credit utilization this month. That means I had enough charges on my credit cards that I had spent 20% of my combined credit card limits. One thing you should know about my spending habits is that I charge nearly everything to my credit cards and then pay them off in full every month— it’s how I make so much money from my credit card rewards. So the bachelorette expenses aren’t that whole 20%. But I normally spend around 10% of my limits, sometimes 12%, and this month the extra charges bumped me up to 20% for the first time in a very long time.

How I Fixed It

This is the easy part. I used the money the bachelorette party attendees paid me and immediately paid off two of my credit cards in full. That’s brought my total utilization down to about 7% right now. (You can see how your utilization is impacting your credit scores for free every month on Credit.com.) I don’t plan to apply for any new credit this month, so a temporary credit score drop is something I can weather without issue. A healthy utilization rate is under 30%, but as you can see from my story, it’s even better to keep it under 10%. I have a good credit score, and still do after the slight ding, and I want to keep it that way.

At publishing time, the Chase Sapphire Preferred Card is offered through Credit.com product pages, and Credit.com is compensated if our users apply for and ultimately sign up for this card. However, this relationship does not result in any preferential editorial treatment.

Note: It’s important to remember that interest rates, fees and terms for credit cards, loans and other financial products frequently change. As a result, rates, fees and terms for credit cards, loans and other financial products cited in these articles may have changed since the date of publication. Please be sure to verify current rates, fees and terms with credit card issuers, banks or other financial institutions directly.

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When Do Americans First Get Addicted to Debt?

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Americans don’t waste any time picking up a credit card habit.

Between the ages of 20 and 30, young Americans typically see their credit card limits skyrocket 450% while their debt rises an alarming 300%, according to a recent report from the Federal Reserve Bank of Boston.

Young adults tend to use their credit cards as a substitute for savings by getting higher credit limits that can help them out in emergencies, says Bloomberg in a story on the Fed report. And once they’ve dipped their toes in, Americans continue to count on their credit cards: 50-year-olds use nearly 40% of their available credit compared with the 50% used by 20-year-olds.

The Fed data shows that debt rises rapidly for Americans in their 20s, before they learn how to pay off credit card debt, and it continues to increase into their 30s. It’s only when American consumers reach middle age that their credit card use levels off. When consumers reach the age of 50, their card use declines and drops to around 20% by the time they hit their 70s.

“Credit and debt show extreme life-cycle variation, much larger than the changes in income or consumption,” Boston Fed authors Scott L. Fulford and Scott Schuh conclude.

Strikingly, Americans who use their credit cards the most are more likely to keep on piling up the debt if they receive a credit limit increase. “Revolver” card users – meaning those who carry a balance from month to month as opposed to “convenience” users who pay off their balance every month – will increase their debt by 1.3% in just three months if they receive a 10% credit limit increase. As a result, the Fed finds, their debt will rise nearly 10% over time.

Only about 35% of American card users between the ages of 25 and 50 are convenience users, while the rest of credit consumers revolve their debt from month to month despite high interest charges.

Getting out of debt is the best way for 20-somethings to begin saving earlier in life, the Fed authors suggest. They note that consumers who opt to revolve debt may be using their credit availability in the mistaken belief that it is a form of wealth.

“Paying off credit card debt has a riskless return that averages around 14%, which no other asset class can match,” Fulford and Schuh write.

Your debt may be having an impact on your credit scores as well. Your credit utilization is the second most important factor in your credit score, and if you’re spending over 30% of your limits, it may be dragging you down. You can check your credit utilization and get two of your credit scores for free every month on Credit.com.

More on Managing Debt:

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5 Things Keeping You From a Perfect Credit Score

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A perfect credit score isn’t the most practical goal: There are hundreds of scoring models, and even the same score can vary significantly month to month, because your credit history is constantly being updated.

Of course, perfectionists don’t care about practicality. If you’re one of them, striving for that “perfect” 850 credit score (the highest on many common scales), you can check your credit history and see if any of the following five things are blocking your achievement. (You can do so by pulling your credit reports for free each year on AnnualCreditReport.com and viewing your credit scores for free each month on Credit.com.)

1. You Spend Too Much

Credit utilization — i.e, how high your credit card balances are compared to your credit limits — is one of the easiest adjustments you can make to your credit score. Even if you use very little available credit, say, less than 10%, you can still see improvements in your credit scores by using even less. You could see your score fluctuate if you go from using 3% of your available credit to 2%. Either you need to have high credit limits, spend little on your credit cards, pay off your credit cards more often than necessary or a combination of the above to keep your credit utilization as low as possible.

2. Your Credit History Is Short

The only thing that can give you a long credit history is time. Even if you’re doing everything right — making payments on time, keeping credit card balances low, rarely applying for credit and maintaining a mix of accounts — there’s nothing you can do but wait for your oldest accounts to age. Generally, if the average age of your credit accounts is younger than seven years, your credit history is considered short. Have patience and keep old accounts open, unless you have a really good reason to close them.

3. You Don’t Have a Mortgage

Account mix — or having a variety of installment loans and revolving credit accounts on your credit history — makes up about 10% of your credit score. If you have a lot of credit cards but no auto, home, personal or student loans, your score could benefit from adding one of them. Conversely, if you only have student loans, adding a credit card to the mix could also help. Account mix isn’t nearly as important as making loan payments on time or keeping debt levels low, but it could be responsible for those few points that sit between you and credit score perfection.

4. There’s an Error on Your Credit Report

Review credit reports carefully, especially if you feel like your credit scores are lower than they should be. Credit reporting errors are common, and to get them off your report you need to dispute the incorrect information with the major credit reporting agencies. Inaccurate, negative information can seriously tank your scores, and the longer it goes unresolved, the more likely you’ll see effects in other areas of your finances, such as higher interest rates for credit products.

5. You Made a Mistake Years Ago

The last seven years in the U.S. economy were tumultuous, and your credit score might still reflect that. Most negative information, like late payments and debt collection accounts, can remain on your credit reports for seven years. The older the information, the less impact it has on your credit scores, but until they age, you’ll have to deal with slightly lower scores. No matter how recent a negative trade line on your credit report is, the best thing you can do is move forward. Focus on making smart credit moves to offset any mistakes from the past.

Obtaining a perfect credit score isn’t easy. Credit scoring algorithms are complicated, and even if you do attain the highest score, you likely won’t keep it forever. Once you’ve crossed that “excellent credit” threshold of about 750 (on a 300 to 850 scale), you’ll qualify for the best interest rates and credit products. Whether you have a 799 score or an 850 won’t matter to anyone but you.

More on Credit Reports & Credit Scores:

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