Credit Utilization

Updated 02/05/18

One of the biggest factors that credit models look at when calculating a credit score (it makes up 30% of a Fico score) is credit utilization. Credit utilization means how much of your credit line you utilize. The less money you spend on your credit cards, the less money you have in debt, compared to how much money you have available to spend (your credit line). Of course, that makes you look like someone that is well and able to manage lines of credit without defaulting. Obviously, this is what lenders like to see. So the less you utilize your credit card, the better your credit utilization will be. The opposite is self-understood as well.  The more you utilize your credit card, the worse your credit utilization will be.

High Credit Utilization

As discussed above high credit utilization is bad for your credit and can hurt your credit a lot. As Fico disclosed credit utilization is part of the amount owed factor that accounts for 30% of your credit score. There is a common number known: that more than 30% utilization is bad for your credit and less is good. People look at this as if 29% is perfect and by 30% you fall off the cliff. But that’s not accurate. High utilization is calculated by brackets of about 10%-15%. The higher the bracket you fall into, the bigger affect your utilization will have on your credit score. That being said, starting by 0%, every 10% to 15% more that you spend, will slowly start hurting your credit more and more.

There are reports that 0% utilization is also not good, since it shows that you don’t have too much experience with credit.  Therefore, it is recommended that a few of your credit cards, but not all, should have a little usage, but in order to optimize your score, keep it below 10%.

High credit utilization is calculated by every individual credit card and by all your credit cards in total. If you have five credit cards, and each has a $10,000 line of credit, and you spend $5,000 on one credit card, then your score will drop a lot, even though your overall utilization is below 15%. But because one credit card has a utilization of 50%, that alone will have a big effect on your credit score. Worse will be, if you swipe, between all of your accounts, more than $25,000 which will cause you to have an overall utilization of 50%.

It’s also important to point out that charge cards or cards without a preset credit limit can be very tricky on how the utilization is calculated. In most cases, your credit limit will be your highest balance, so if you spend about the same amount every month, than using a charge card or a card with no preset limit may be very damaging for your credit. That’s because Fico will look at your credit utilization as close to 100%. (I Hope to post more about this in the future.)

Installment Loans

The negative affect of high credit utilization is only for a revolving account (credit cards or any loan that does not have a fixed amount that you need to pay every month). Installment loans (mortgages, car leases, or loans that have the same fixed amount to be paid every month), are not part of the credit utilization calculation.

(Doctor of Credit claims that even installment loans have a %5 effect on credit utilization.)

Short Term Effect

Even though maxing out a credit card is almost as bad as a late payment, it’s different in that a late payment can take you credit score up to two years to recover from, while credit utilization only effects your score for as long as you carry the high balance. Once you pay off your balance, your score will go back up. You can read more about this here. 

Business Credit Cards

One of the big advantages of using a business credit card is that most banks do not report business credit cards on your personal credit report, as long as you make on time payments. Therefore, business cards can be maxed out without them affecting your credit score.

Paying Before The Closing Date

If you ever want to make a large purchase on a credit card or you want to meet a spending requirement for a credit card bonus, but you don’t want to be hurt by the high credit utilization, use this simple trick. Just pay off the balance before the credit card reports your balance to the credit bureaus, which is usually on the closing date. You can find a complete list here.

You may also want to read The 5 Most Important Factors In A FICO Score

Good luck on building your credit! See you next week!

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