If you have ever had a credit card before, then credit utilization is a term that you have probably heard tossed around more than once. However, if you’re like many people, you might not be entirely sure of what it means.
Knowing what credit utilization is and how to ‘utilize’ it to your best advantage are key to making full use of its benefits. Below we will discuss the definition of credit utilization, why it is important, how your credit score is calculated, and how you can improve your overall credit.
What is Credit Utilization?
Credit utilization is a very important single component of your overall credit score. It is a three digit number that refers to how well you are utilizing your current credit. You can find your personal credit utilization by taking your total credit balances and dividing it by your total credit limit. The percentage that you reach is your credit utilization.
Credit utilization is measured at your monthly close date. It is then reported to the various credit bureaus. Reporting periods are generally 90 days long. This allows you to make charges and then pay them off quickly without hurting your credit utilization.
Why is Credit Utilization Important?
Credit utilization is quickly becoming one of the most important factors of your overall credit score. It is something that you should keep a close eye on. It is so important because it affects your credit score and your ability to borrow money from a creditor.
Five key factors are taken into consideration when creditors take your credit score into consideration. They are payment history, amounts owed, length of credit history, new credit, and types of credit used. By considering these factors, creditors can determine how risky it is to give you a loan. The riskier (or the higher your utilization), the lower the chances of your receiving help. The safer (or lower your utilization), the higher the chances of your receiving help.
How is a Credit Score Calculated?
As your credit score is a very important factor to credit utilization it is important to know how it is calculated. Knowing how your score is calculated will help you improve your credit utilization and thus put you in good terms with creditors. Knowing how your credit score is calculated is a credit utilization tip in itself.
As mentioned above, payment history is a key factor of your credit score. It accounts for 35% of your score and is perhaps the most important single factor in calculating it.
Paying your bills, in full and on time, has an extremely positive influence on your score. Failing to make payments or paying them late has the opposite effect – it will hurt your score. The more recent your missed payments are, the bigger an impact they will have on your credit score.
Once again we get to credit utilization. As you now know, credit utilization takes into consideration the amount of debt you have and the total credit available to you. This section accounts for about 30% of your credit score.
You will be considered a huge risk if your accounts are maxed out. This is because it will look like you are struggling to pay off debts that you already have (even if you aren’t). If your accounts have relatively low balances, your overall credit score will be helped, and you will be more likely not to be considered a risky prospect.
Length of Credit History
Accounting for just about 15% of your credit score, the length of your credit history will show a creditor how consistent and responsible you are about your payments. If you have a credit history that spans a long period of time (say 5 years or longer), then you will be seen more highly in the eyes of a creditor, especially if you haven’t missed any payments. A lengthy credit history with no missed payments will help raise your credit score.
Number of Accounts
The number of accounts that you have will play around a 10% role in determining your overall credit score. Having your credit spread out into multiple areas – for instance, credit cards, consumer loans, and secured debt – will positively benefit your credit score. If you have too much of the same kind of credit (or just one type in total), your credit score could be negatively influenced.
Accounting for another 10% of your score is the number of new credit accounts that you have recently opened or completed. When you apply for a lot of credit all at once, it makes you seem like you’re struggling financially. This marks you as a risk and lowers your score. It is best not to open several new accounts all at once unless you are looking around to see who can give you the best rate on a new loan. If that is the case, you generally shouldn’t have any need to worry about it affecting your score.
How to Improve Your Credit Score
Just by simply reading through the information above and understanding how your credit score is calculated gives you the tools to improve your credit score.
To improve your credit score you should make payments on time, pay off any delinquent payments (with the most recent first), work on your credit utilization, and consider opening a new account (but not too many all at once!). It is obviously not easy to improve your score – especially fast – but it can be done.
Now that you know what credit card utilization is, why it is important to you, how your credit score is calculated, and how you can improve your credit score, you have all of the credit utilization tips you could ever need. You can now use these credit utilization tips to improve your attractiveness to creditors and to improve your overall credit score.