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You know the old saying, use it or lose it? To some extent, that’s true with credit utilization and credit cards, but you can also lose it if you use it too much. Card issuers won’t like it if they approve you for a credit card and you never use it. Likewise, card issuers won’t like it if they send you a credit card and you max it out and then don’t make the payments. Somewhere in the middle is the sweet spot of credit utilization and keeping yourself out of unaffordable debt. Here’s what you should know.
What Is Credit Utilization and Why Is It So Important?
Credit utilization is the second greatest factor that drives your credit score. Payment history carries the most weight because it counts for 35% of your score. But utilization is a close second at 30% of your score. But what is credit utilization, why is it so important and how can you use credit wisely to leverage this factor for a better credit score?
What Is Credit Utilization?
Credit utilization is a ratio of the total credit you have available versus how much of it you’re using. For purposes of simplification, let’s say you have one credit card with a $3,000 total line of credit. If you charge $2,000, your using two-thirds of your available credit which is 66% percent. That’s way too high, and even if you make the payments on the card account on time, your credit score will suffer until you drop down to a preferable level.
Why Is Credit Utilization So Important?
If you’re tapping into a lot of your credit line, the card issuer might assume you’re having problems managing your money and are over-extending yourself by over-spending and they might lose out if you can’t afford to pay your debt. Card issuers prefer to see you use your credit cards regularly, pay a good bit of the balance off each month and never run late on a payment or give them cause for concern about your creditworthiness. It’s a measure of your ability to use credit wisely.
Should You Just Avoid Using Your Credit Cards?
Things can get tricky with credit utilization. The way to keep your utilization low is to pay off your cards in full each month or as close to full as you can. However, simply avoiding using your cards to keep your utilization low is not the best answer in most cases. Why? Card issuers want you to use your cards. If your accounts sit inactive, they will close them, and that can damage your credit score.
Plus, if you use your cards regularly and pay off responsibly, you’ll get increased lines of credit which can keep your utilization lower if you ever do have to carry a balance. The ideal sweet spot is for you to have lots of available lines of credit that you don’t tap with as little of a balance carried over each month as possible – while still utilizing your credit cards to keep the issuers happy with you.
What Is a Good Level of Credit Utilization?
Some websites will tell you that as long as you’re under 30% utilization, you’re fine. However, both FICO and Vantage Score advise you to keep utilization under 20%. Also, there are two ways to look at utilization. First, is on individual cards and second is overall. For instance, if you have that $3k credit limit from the example above and a $2k balance, that card’s utilization is at 66% which is too high. If you have two more credit cards with healthy credit lines, so you have a total available credit of $10k, but you only have that $2k balance, your overall utilization is 20%. The latter number is important but maxing out even one card is not a good idea because that card issuer might cut your credit limit.
Because you need to use your cards to keep the card issuers pleased and offering ongoing credit limit rises, one approach to consider is using credit cards for things you’d pay anyway, then pay off in full on your payday. For instance, if you use a card for your monthly Netflix, it gives activity without driving a balance. You can do the same for utilities or your cell bill. That allows you to use your cards responsibly without getting in over your head.
To find out more about using credit responsibly to rebuild your credit score after bankruptcy, contact Credit Score Keys. Call 919-495-2365 for a free consultation.