If you have ever wondered why your credit score went down even though you paid your bills on time, credit utilization might be the reason. It is the second most important part of your FICO score. Coincidentally, it is also one of the things most people do not understand.
What Is Credit Utilization?
Credit utilization is the percentage of your total credit limit that you are currently using. It is for credit cards and lines of credit, and not for loans like a house or a car. There is a simple formula to help you understand it better.
Credit Utilization = (Total Balances ÷ Total Credit Limits) × 100
So if you have two credit cards with a total limit of $10,000 and you owe $3,500, your utilization is 35%.
Why Is It So Important?
Credit utilization is 30% of your FICO score. It is the second most important part after paying your bills. Banks look at this information to judge how you use money.
For example, using a lot of your credit shows you might need too much help from banks. On the other hand, not using it much shows you handle money well.
According to Experian, people with FICO scores over 800 use only about 6% of their credit. People with “Fair” scores (580-669) often use more than 50% of their credit.
What Is The Right Utilization Rate?
There is no one perfect number, but here is a simple list:
| Utilization Rate | Impact on Score |
|---|---|
| Below 10% | Best for your score |
| 10% – 30% | Generally considered good |
| 30% – 50% | Starts to hurt your score |
| Above 50% | Significant negative impact |
Most people say to stay under 30%. That is a good rule, but if you want a very high score, your goal should be staying under 10%.
Individual Card Utilization Also Counts
Here is something many people do not know. FICO looks at each card and not just your total credit. For example, suppose your total use might be 20%. But one card is 95% full while others are empty. That full card will still hurt your score even if the total looks okay.
Your goal should be to keep a balance on every card. Forget the total amount.
How To Lower Your Utilization
Here are some tips that you can use to lower your individual card utilization:
- Pay your bills before the statement closing date. Your bank usually tells the credit offices about your balance at the end of the billing cycle, and not on your due date. When you pay early, the bank reports a smaller number.
- Ask for a higher credit limit. If your limit goes up and you spend the same amount, your percentage goes down automatically. A $3,000 balance on a $6,000 limit is 50%. On a $10,000 limit, it is 30%.
- Use more than one card for your shopping. Instead of putting all your costs on one card and making it full, use different cards to keep each card’s balance low.
- Make more than one payment per month. When you pay in the middle of the month, it lowers your balance before the bank reports it to the credit offices.
Conclusion
Credit utilization is one of the fastest things you can control. Credit history takes many years to build, but utilization can change in just one month.
If you pay your bills and keep the balance on each card low, you will see a difference. If you can, try to stay under 10% of your limit. If you do these things, your score can get better very quickly.
