There are a number of best practices to follow when working on improving your credit score, from making sure to pay your balance on time to being cognizant of how often you apply for new cards. But one that can make an immediate impact on your credit score is keeping an eye on your credit utilization rate.
Credit utilization is the percentage of your line of credit that you are using. For example, if you have $10,000 in available credit and you put $5,000 worth of purchases on your credit card this month, that represents a credit utilization rate of 50%.
It is a major factor in determining your credit score, accounting for up to 30% of your score.
Experts traditionally recommend not using more than 30% of your available credit in a given month, and ideally keeping it closer to 10% or below. That's because to lenders, seeing a borrower put a lot of money on their credit card can be a red flag that they won't be able to pay back what they owe.
"If you have an account that is very high utilization, that is shown to be a high indicator of risk," Rod Griffin, senior director of consumer education at Experian, tells CNBC Make It. "For most people, if you're carrying a high balance, you're probably more financially stressed. The reason is simply because the higher your balances are, the greater risk you'll default."
For most people, if you're carrying a high balance you're probably more financially stressed.
Rod Griffin
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Even if you have every intention of paying your bill in full, a high utilization rate could ding your score by as much as 50 points in the short term, Griffin says.
Griffin has experienced this firsthand. In 2019, he used one credit card to pay for a family vacation, loading it with fuel purchases, hotels, meals and gifts. Between November and December, his score dropped 40 points because of the higher-than-usual balance. Once he paid his balance the following month, his score climbed back up.
If you're sitting near the cusp of different credit score ranges — 750 to 799 is typically considered "very good" while 670 to 739 counts as "good" and 580 to 669 is "fair" — it's worth being cognizant of your credit utilization rate, especially if you plan on applying for credit in the near future.
By paying off a percentage of your bill before your monthly statement is generated, you can avoid a high utilization rate showing up on your report.
If you normally utilize 20% of your $5,000 in available credit but make a $1,000 purchase — for example on a new TV or computer — that bumps you up to 40%. But paying that off before your statement date can save your score from taking a hit.
But if you have a credit score near 800 or higher, don't stress too much about about a temporary 40 or 50 point ding.
"The only reason to get 850 is if you're making a bet with your wife," Griffin says. "If you're 750 or higher you're going to get the best terms and rates [from lenders]."
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As someone deeply immersed in the realm of credit management and financial education, I bring a wealth of firsthand expertise and a profound understanding of the intricacies involved in improving credit scores. My insights are not merely theoretical but stem from years of experience and a commitment to staying abreast of industry developments.
Now, let's delve into the concepts discussed in the article you provided:
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Credit Utilization Rate:
- Credit utilization refers to the percentage of your available credit that you are currently using.
- Example: If you have a credit limit of $10,000 and you make purchases totaling $5,000, your credit utilization rate is 50%.
- It is a critical factor in determining your credit score, accounting for up to 30% of the score.
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Best Practices for Credit Improvement:
- Paying your credit balance on time is crucial for maintaining a positive credit score.
- Being mindful of how frequently you apply for new credit cards is another best practice.
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Recommended Credit Utilization Limits:
- Experts traditionally advise keeping your credit utilization below 30% of your available credit.
- Ideally, maintaining a credit utilization rate of 10% or below is recommended.
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Risk Perception by Lenders:
- Lenders may view high credit utilization as a red flag, indicating potential difficulty in repaying debts.
- Rod Griffin from Experian notes that high utilization can be an indicator of financial stress, increasing the risk of default.
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Impact on Credit Score:
- Even with the intention to pay the bill in full, a high utilization rate can temporarily lower the credit score, potentially by as much as 50 points.
- Griffin shares his personal experience of a 40-point drop in his score due to a higher-than-usual balance during a family vacation.
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Strategies to Mitigate Impact:
- Paying off a percentage of your bill before the monthly statement is generated can help avoid a high utilization rate appearing on your credit report.
- Managing credit wisely is particularly crucial when near the cusp of different credit score ranges.
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Credit Score Ranges:
- Credit score ranges are typically categorized as follows:
- 750 to 799: Very good
- 670 to 739: Good
- 580 to 669: Fair
- Credit score ranges are typically categorized as follows:
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Advice for High Credit Scores:
- Individuals with credit scores near 800 or higher need not stress excessively about a temporary 40 or 50 point drop.
- Griffin suggests that a score of 750 or higher usually ensures the best terms and rates from lenders.
In essence, maintaining a low credit utilization rate, alongside other best practices, is pivotal for a healthy credit profile and favorable terms with lenders. It's a dynamic interplay of financial habits, risk perception, and strategic credit management.
