Credit Utilization Explained by A Credit Expert
When it comes to understanding your credit, you may feel completely lost. You may hear terms and have no idea what they really mean. Do not feel bad because you probably are not the only one. Perhaps you have tried to get a loan in the past and were denied, but you did not fully understand why. There are definitely some things you should know when it comes to using credit properly. Once you know the details, it is easier for you to make good decisions when it comes to credit usage. Continue reading to find out all the details about proper credit utilization, your credit score and more information about using credit.
What Is Credit Utilization?
It is a fairly easy concept to understand when you have all the information. The simplest definition is ”The percentage number that shows how much of your available credit you are using”. It is the balance between your outstanding credit and the credit limit of all the accounts. Your outstanding credit is on credit cards and lines of credit. If your credit utilization is high, it can negatively impact your credit score. A good rule of thumb is to keep it below 30 percent.
Here is an example of credit utilization:
You have two credit cards, each with a credit limit of $2,000, so your total credit is $4,000. If you have a balance of $2,000, that means you are utilizing 50 percent of your credit. If you want to have a credit utilization of $1,200, that would keep you around 30 percent.
An easy way to determine your credit utilization: (balance of your credit cards/your credit limit) x 100
What Is My Credit Report?
Your credit report is an important part of any attempt to gain credit. It even matters when renting an apartment, obtaining car insurance, and even being selected for a job. Any time you try to get some type of credit, the lender make a hard hit against your credit report. There is a difference between your credit report and credit score even though people mistakenly use them interchangeably. I will touch on your credit score in a few moments, but for now let us focus on your credit report. It contains details about your credit history. You actually might be surprised at all the details it contains about you.
What Does Credit Report Show?
You credit report lists every address you have lived and every name you have used. Your credit report shows all phone numbers you have used and every job you have held. Information about your spouse could be on your credit report, especially if that spouse was involved in any credit transactions. Your credit report shows your entire credit history, including credit cards, homes, balances in your bank accounts.
It also shows every missed or late payment that you have made. In addition, it shows how late your payments were, 30 days, 60 days, 90 days, etc. It shows your credit utilization and any bankruptcies you have had. If you have hand any businesses, that shows up on your credit report, also.
What Else Should I Know About My Credit Report?
Your credit report does not indicate why you may have missed payments, or made late payments. There may have been circumstances outside of your control that caused blemishes to show up on your credit report. Circumstances, such as divorce, can have a major impact on your credit history. You should pull your credit report once a year and take a good look at it. Often credit reports have wrong information on them, so it is important that you know what is on your report. If you see something that is incorrect, you should address it immediately. Incorrect information on your credit report can cause your credit score to drop. However, once you make those corrections, your credit score can improve.
Taking a look at your credit report gives you an accurate picture of your credit utilization. It shows you how much debt you have and gives you insight to your debt to income ratio. This can highlight the areas in which you need to work. It can show you that you need to reduce how much debt you are carrying by paying it off sooner rather than later. It can also show that you have a problem making payments on time and remind you to be better at making your payments timely.
Keep in mind that there are three credit reporting agencies and not all lenders report to all three of them. Department store credit cards and auto dealerships that finance their own loans may only report to one agency. You should make sure that the number being reported by the credit agency is your FICO score. This ensures that your credit score is within the same basic range, no matter to which agency your information is reported.
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What Is Credit Score?
Your credit score is a three digit number that ranges between 300 to 850. A score of 850 is an excellent credit score, but really anything above 800 is considered excellent. Anything within the range of 670 to 800 is considered good. Most people have a credit score between 600 to 750. When your credit score falls between 580 to 669, it is considered ok, or fair. Anything that is 570 or below is considered poor, or bad.
This number is an indicator to lenders about your credit worthiness. It is also an indicator to lenders about how risky it is to lend you money. If they feel you are a high risk, they may not allow you to borrow money. If they allow you to borrow money, they may add a higher interest rate to your loan. The opposite of that is also true, the lower your credit score, the less risk you pose to a lender. If a lender feels you are less of a risk, then you get a better interest rate.
What Calculation Is Used To Determine Credit Score?
There are many factors that are figured into the calculation to determine your credit score. Your credit utilization is only one part of the equation. Your payment history is about 35 percent of your total credit score. When you pay your bills on time it has a positive impact on your payment history. The more lines of credit that you have with timely payment histories are a good impact on your credit score. Your credit utilization accounts for 30 percent of your credit score. This ratio is your outstanding debt compared to the available credit that you have. In simple terms, this is the amount you owe on your credit cards compared to your credit limit.
Another factor in determining credit score is your credit history length. Those with little to no credit history may also have a low credit score because they have not had enough time to build up proper credit. This is 15 percent of your credit score. A FICO score looks at the age of your oldest and newest accounts and the median of all of them. The mix of credit you have impacts your credit score. This is 10 percent of your credit score and counts credit cards, mortgages, all types of loans, and store credit cards.
The better mixed your lines of credit are, the better is looks on your credit score. Lenders like to see that you have a good mix of credit available to you. 10 percent of your credit score is focused on new credit. If you have opened up many different credit lines in a short amount of time, it is negatively reflected in your credit score.
Does Credit Utilization Impact My Credit Score?
Yes, your credit utilization absolutely impacts your credit score. It takes up 30 percent of your credit score. Just to recap, credit utilization is the amount of debt you have versus the amount of credit. It means that your outstanding balance on a credit card or line of credit is high compared to the amount of available credit you have. Lenders feel that if you have a high ratio of credit utilization, you are less likely to pay your bills. Lenders feel that when you have a large amount of money to repay, you may not have the funds available to repay and therefore will not.
All is not lost if you have a high credit utilization ratio. Lenders do look at other things such as your payment history. If you payment history shows on time payments and no record of collections, a high utilization could have less negative impact. A lower utilization percentage is better however, no utilization is not better. If you constantly show a zero balance, it seems as though that card is inactive. This can have a negative impact on your credit score. Keep in mind that what matters most often is your credit utilization and balance information at the moment. If a lender is pulling your credit report today and it shows utilization under 30 percent, that is what the lender looks at. A lender will not typically look at your historical utilization.
Ways To Control Credit Utilization
The good news is there are ways for you to control your credit utilization. A good rule of thumb is to keep your balances as low as you can. Based on what I told you earlier, you do not really want to keep them at $0, but you should try to keep them low when you can. That may seem challenging, especially if you use your credit card for everything. I know quite a few people that use only their credit card during the month and never pay anything from their bank account. When it comes time to pay the credit card bill, they cut one payment from their bank account to their credit card.
Limit Your Spendings
There are definite positives and negatives to this, but it can cause your utilization to be high towards the end of the month. You should keep tabs on your credit card balance throughout the month, so that you do not get to the end of the month and have a high utilization percentage. You could set an alert on your credit card so it warns you when you are getting within a certain range of your limit. If you have more than one credit card, you should use them all to spread out your utilization rate per card.
Reconsider Closing a Credit Card Account
You should work hard to pay your full balance every month, especially if you use your credit card as your vehicle to pay for everything. You may want to consider making two payments per month. This helps you have a lower utilization rate throughout the entire month. If you are considering closing a credit card account, you may want to reconsider. Think about how it impacts your utilization before you close that account. One it helps add to the mix of credit accounts that you have open, which is good for your credit score. Keeping more than one card open, especially if you have one that you use infrequently, raises your credit utilization ratio.
Here is an example with numbers to highlight my point:
You have one credit card with a $3,000 limit and a $100 balance. You have another credit card with a $3,000 limit and a balance of $700. Right now, you have $6,000 or credit and $1000 balance. That is a 14 percent utilization, which is not bad. However, if you pay off the $100 balance and close the first card leaving you with a $700 on a credit with a limit of $2,000, you utilization is 35 percent, which is higher than your goal of under 30 percent. In this case, closing that other credit card negatively impacts your credit score.
A Few More Ways To Control Utilization
There are a number of ways you can take control of your credit utilization, so I am going to list a few more for you. You can find out to which credit agencies your lenders report. Believe it or not, they all request information at different times of the month. While this may not seem like a big deal, let me explain why it could be.
Say your credit card company reports to their agency on the 5th of the month. Your credit card payment is due on the 9th of the month. Your credit card has reported to their agency before you could pay your bill and this month you could have a higher balance because you made someone time purchases. However, if your credit card company reports on the 14th of the month, you have paid your bill and it has posted, so the balance on your credit card is lower. You can contact your credit card company and find out when they report to the credit agencies. Once you have this information, you can pay your balance before they report it.
You can ask for a credit line increase. If your credit limit is too low, it is hard for you to stay under 30 percent utilization. One of the ways to fix that is to get a credit line increase. If you consistently pay your bills in full and have a history of on time payments, it should not be difficult to get your credit line increased. One thing you must keep in mind if your credit limit is increased, you cannot spend more money. That defeats the purpose of the increase because if you spend more than your utilization goes up.
How Does My Credit Impact My Ability To Get A Credit Card?
Your credit score makes a huge impact on just about everything you want to do in life. I know that may sound over the top, but it is true. The sooner you accept it and strengthen your credit score, your life becomes much easier. If you have a high credit card score, up around 800, you will most likely get approved for any credit card you want. You may also find cards with many bonuses and rewards.
Good and Bad Credit Score
Pay attention to any offers you receive to determine the end date. If your credit score is above 740, you also have the same card options. A good credit score above 670 or so will get you most credit cards as long as your income supports your ability to make regular payments.
When your credit score dips below 670, you begin to see some difficulty getting approved for credit cards. If you have bad credit, there is a card that you may need to obtain to help improve your credit. It is a secured credit card. This type requires that you give the credit card company a deposit to make you less of a risk. These cards start with a low balance and the balance is based off the deposit you make. Over time, as you prove you will not default on payments, you credit limit increases. No matter which credit card you receive, be sure to keep an eye on your credit utilization.
What Other Factors Impact My Ability To Get a Credit Card?
There are some tips of which you should be aware when you would like a credit card. You can do some things and avoid others in an effort to gain approval for a credit card. One thing you should avoid is applying for too many cards at one time. For each card, the company makes a hard inquiry to your credit. This can be harmful to your credit score.
Your Credit History
In addition to your credit score, lenders look at a few other factors. Once you are aware of these factors, you can help yourself by making sure they are in a good place. Lenders look at your credit history this includes items such as your credit utilization and other credit card information. It allows the lender to see an extensive history of your spending and repayment. This is a better picture of your habits than just your credit score.
Your Income
Your income is another factor. Lenders want to know that you can make payments. A steady income makes them feel secure that you are able to do just that. Income is not factored into your credit score. Another factor lenders want to know is the cost of your housing. This gives the lender some insight as to whether you are living within your means. If it seems you have a mortgage for more than you can afford, a lender may not be willing to give you any more credit.
While we are still on topic of credit cards, below you can find some of the options worth considering. Put all the information required and see which offers that work with your credit score, are out there:
Can A Budget Help Me?
I am a huge advocate of creating a budget. It is always a great idea to have a budget. A budget puts you in control of your spending instead of your money being in control of you. When you know how much money you have each month, you can decide what to do with it. You can decide how much to save. You can decide if you can afford to pay back a loan. There are many tools and websites available to you to assist with creating a budget that works for you.
How to Create a Budget?
How Do You Create a Budget For Almost Anything?
Creating a budget is fairly simple. You write down your income in one column and all of your expenses in a separate column. You subtract your total number of expenses from your total income and that tells you how much money you have at the end of the month. Hopefully, it is not a negative number.
If it is, that means it is time to make some hard choices, but more about that in a minute. If the number is a positive number, that indicates to you how much money you have left after all your bills are paid. Unless you figured savings into your expenses, which would be great if you did, here is where you have to make decisions about savings.
You should always put money into some, or multiple savings accounts. This number also indicates how much you can afford to pay back in credit card bills or loans. This number can guide you on where your credit utilization should sit. You will not be able to do any of this unless you create a budget for yourself. It may seem like a daunting task at first, but once you sit down and create a budget, you get to take control and remain in control of all your spending.
How Can I Save Money?
Now that you have created a budget, if you are like most people, you have found that you spend more money than you realized. You probably also found out that you do not save enough money and have little left over to save. You may also have realized that your credit utilization is higher than you would like. This is the part that tends to scare people. You look at the numbers and say, "Gulp, now what?" Well, now you begin to dig into your spending. You can start with the easy stuff. Do you have a gym membership that you do not use? If so, cancel it. Do you have other subscription services that you do not use? Cancel them, also.
Another easy one is to look at how often you eat out and cut it. You can save an enormous amount of money by packing your lunch and cooking dinner. I realize that this requires another resource, time, of which you may have little. However, there are some ways you can eat at home and prepare meals quickly. If you cut back to eating two or three meals per week out, you can save hundreds of dollars. Try it for a month and see how much you save. You may find that it is worth it.
Those are some easy savings for you. After that, it gets a little harder. If you buy coffee out, consider making it at home and taking it with you. If you have some bad and expensive habits, maybe now is the time to consider breaking them.
Take a hard look at your credit utilization and cut back on using your credit cards. When you use credit cards often, it is hard to fully understand how much you are spending because it does not come directly from your bank account.
Conclusion
I have talked a lot about proper credit utilization. Arming yourself with the knowledge about credit utilization is the best thing you can do to ensure you are staying within your means.
It also helps you maintain the best credit score and credit health possible. These items only help you towards on your path to financial freedom. You should always make sure you save money. You should always keep an eye on your credit utilization to ensure it stays in a range that is best for you.