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To charge or not to charge: Credit utilization is the question

Credit cards shouldn't be as complicated as studying Shakespeare.

Gregory Andersen

Managing Editor at Tally

August 30, 2018

Most people would agree maxing out a credit card is bad idea.

But fewer people are clear on exactly how much of their credit they should be using.

Your credit utilization is an important factor in determining your credit score. And if you're using too much of your credit, you’ll pay for it later.

What’s credit utilization?

Your credit utilization is the amount of credit you’re using at any given time. Sometimes referred to as your “credit utilization rate," it’s the amount of revolving credit you’re currently using divided by the total amount available from your revolving line of credit.

It’s essentially how much you owe divided by how much you’re able to borrow, and it’s usually expressed as a percentage.

Here’s how it works: You’re offered a $5,000 revolving line of credit, and you’ve used $2,000 to date. Your credit utilization is 40% because you’re utilizing 40% ($2,000/$5,000) of the credit that’s available to you.

You can calculate your overall credit utilization or do it individually for every credit account.

Who cares about credit utilization?

Credit score providers — and you should, too.

FICO and VantageScore, the two primary credit score providers, consider your credit utilization when calculating your credit score. Each has a varied model and calculates your credit score in a different way: FICO says your credit utilization can affect up to 30% of your credit score, while VantageScore says it's is a “highly influential” factor.

If you have a low credit utilization rate, credit score providers see it as strong indicator of your financial responsibility. It means you’re managing your existing credit well and that you’re less of a risk when it comes to future credit and loans.

What’s the ideal credit utilization rate?

Your credit utilization rate should be 30% or less, according to FICO and VantageScore.  

Just as a low rate can indicate your ability to manage your existing credit, a high rate can be a red flag for both lenders and creditors about your ability to repay what you borrow.

If you have a low credit utilization rate, credit score providers see it as strong indicator of your financial responsibility.

This 30 percent threshold is not a cliff. Think of it more like a sliding scale — the closer you are to 30 percent credit utilization, the better your credit score will be.

Your overall credit utilization is the average rate spread across all credit accounts. So, even if your rate is below 30% on three of your credit cards, a fourth card with a higher rate can have a significant impact.

Will a credit limit increase help?

The easiest way to improve your credit utilization is to simply reduce spending, but that’s not always an option.

As an alternative, you can request a credit limit increase. Requesting a credit limit increase can boost your purchasing power and simultaneously lower your credit utilization — and that will likely help your credit score.

Requesting a credit limit increase is more than just asking nicely: You need to show why it makes sense for your credit issuer. Here are a few good reasons:

  • You just got a raise and are in a good position to pay off your debt.

  • Your credit score is on the rise, which shows you’re on the right track.

  • You’ve been consistently making all of your credit payments on time.

On the other hand, it’ll be a harder sell to request a credit limit increase if your credit score is trending downward or if you have recently made late payments.

Importantly: A credit limit increase request can trigger a “hard check” on your credit report, which can have a negative effect on your credit. Check with your credit issuer and ask if the hard check is avoidable.

Should I consider micropayments?

Another way to reduce your credit utilization is through micropayments.

Micropayments are smaller, frequent payments that can keep your balance in check, instead of one lump sum payment every month. Put simply, it’s paying earlier and more often.

Your credit score is based on your credit report, and your credit report is based on the information your credit card issuer reports to the credit bureaus every month.

So, by increasing your payment frequency, you decrease the likelihood that you’re carrying a big balance when your credit card issuer makes its monthly report to the credit bureaus.

Keep in mind that a high credit utilization rate won’t hurt your credit score forever. As soon as you’re able to reduce your rate, you should see a jump in your credit score.

Bottom line: The magic number is 30. Your credit utilization accounts for about 30% of your credit score. If you want your credit score to improve, keep your credit utilization at or below 30%.