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Credit Utilization—What It Means for Your Credit Score

Get answers to 5 FAQ about credit utilization and use it to raise your credit score.

By
Laura Adams, MBA,
Episode #270

When it comes to credit scores, there are several key factors that cause them to go up or down. In this episode, I’ll answer 5 questions from Money Girl podcast listeners and readers about the credit utilization ratio.  

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What is Credit Utilization?

To build excellent credit, making payments on time is king because it makes up the largest percentage of your credit scores. But the next most powerful factor is credit utilization—so I guess that makes it the credit queen!

Your credit utilization ratio is a simple formula that divides your outstanding balance on a revolving account—like a credit card or a line of credit—by your credit limit on the account. For example, if you currently owe $500 on a credit card with a $1,000 credit limit, your ratio is $500 divided by $1,000, or 50%.

The lower your credit utilization ratio the better. A low ratio tells potential lenders and merchants that you’re using credit responsibly. A high ratio says you’re maxed out and may even be getting close to missing a payment.

Now that you know the basics, let’s cover 5 specific questions that I’ve received about credit utilization:

Question #1: What is my ideal credit utilization ratio?

An anonymous reader asks:

“I’m a student and will be getting my first secured credit card soon with a $300 credit limit. To build credit quickly, what’s my ideal credit utilization ratio?”

A secured credit card is the perfect way to build credit for the first time. You make a refundable deposit that could range from $200 up to $3,000 that becomes your credit limit.

Here are 3 secured credit cards that report payment information to the nationwide credit agencies (the only way to build credit), don’t check your existing credit, and charge low fees:

I recommend never letting your credit utilization creep above 30%—no matter if you’re just starting out or already have a thick credit file. Applying this rule to the reader, he or she would never charge more than $90 a month, which is 30% of the card’s $300 credit limit.

If you want to charge higher amounts on a secured credit card, and maintain a low utilization ratio, you can increase your security deposit so your credit limit goes up. If you have a regular, unsecured credit card, you can contact the card company and request a credit limit increase.

Question #2: If I pay off my credit card each month, do I even have a credit utilization ratio?

Frank W. wants to know:

“If I make credit card charges that approach my credit limit each month, but pay off the balance in full by the statement due date, do I have a credit utilization ratio or is it always 0%?

Paying off your credit card each month is a smart way to avoid all interest charges. However, if you’re like Frank and max out your card before paying it off, you may still have a credit utilization ratio that’s dragging down your credit scores.

Credit cards have a date that they report your payment information and account balance to the nationwide credit agencies each month. This date is typically not the same as your statement due date. If Frank’s outstanding balance is high on the date his card company reports it, he’ll have a high utilization ratio.

A good solution for Frank would be to get a second credit card and spread out his charges on 2 accounts. If approved for a second credit card with a similar credit limit, he could cut his utilization ratio in half.

Related Content: Frequently Asked Questions About Your Credit Score

For example, charging $600 on a card with a $1,000 limit is a 60% utilization ratio. But charging $300 on 2 cards that each have limits of $1,000 is a utilization of 30% because the math is now $600 divided by $2,000 ($600 / $2,000 = 0.30).

It’s always better to have low balances on multiple credit cards than to have one card that you consistently max out.

Question #3: When is my credit card’s utilization ratio calculated?

Saket K. says:

“I just paid off all my credit card debt. Going forward I plan to use my cards only for purchases that I can pay off in full each month. When I should pay my credit card bill so the credit agencies only see my balance as $0—when I receive the bill or earlier in the month?”

To know exactly when your credit card reports outstanding balances to the credit agencies, you’ll have to ask them. If they tell you, simply make a full payment before their reporting date.

But if for some reason they can’t or won’t tell you a specific reporting date, here are some solutions to keep your credit utilization ratio as low as possible:

 

  • Request a credit limit increase on your account

  • Spread out your charges among several cards each month

  • Make payments more frequently, like bi-monthly or weekly

Question #4: How is credit utilization calculated when I have multiple accounts?

Lisa asks:

“I have several credit cards with high balances. Is it better for my credit to pay a larger amount to just one of them each month—or to pay smaller amounts on several of them at the same time?”  

Credit scoring models generally score each account’s utilization ratio individually and then add them up for an overall ratio. But having a high balance on just one credit card is a sign that you may be a risk to a potential creditor or merchant—even if you haven’t been late on any payments.

As I previously mentioned, that means you’re better off having multiple accounts with low balances. So Lisa should spread out her payments and make it a goal to get all of her credit cards below a 30% utilization ratio as quickly as possible.

Question #5: Should I cancel a credit card that’s now charging an annual fee?

Dave says:

“I’m fed up with both of my credit cards because they’re now charging an annual fee. Would canceling them really hurt my credit?”

To maintain a good credit history, you need to have at least one credit card. If the card offers rewards like cash back or travel miles, it makes sense to keep it as long as the rewards are worth more than the fee. 

Canceling a credit card can dramatically increase your credit utilization ratio because your available credit on the account goes to zero but you still have the same amount of total debt. That will cause your credit scores to drop right away and could ruin your ability to get new credit—like a mortgage or car loan—in the near future. Lower credit scores can also have side effects like causing your insurance premiums to go up or getting passed over for a new apartment or job that checks credit.

Related Content: What to Know Before You Cancel a Credit Card

But depending on Dave’s situation, if he’s still determined to close his 2 credit cards, a smart strategy would be to do it gradually. He should get a replacement card first, and then cancel one of his existing cards a few months later. Then repeat the process.

The bottom line: It’s impossible to change anything in your credit file without it affecting your credit scores. Don’t let a relatively small issue like an annual fee cause you to make a knee-jerk decision that could hurt your credit and finances in the long run.

To learn much more about credit, download the Credit Score Survival Kit. It’s a free multimedia resource I created as a gift for you with a video tutorial and 3 smart strategies to build excellent credit scores (that you can real or listen to). Plus, I tell you how to save money by getting your credit score absolutely free as often as you want.

Click here to download the Credit Score Survival Kit!

Here’s How to Get More Money Girl!

There’s a huge archive of past articles and podcasts if you type in what you want to learn about in the search bar at the top of the page. Here are all the many places you can connect with me, learn more about personal finance, and ask your money question:

More Articles and Resources You Might Like:

PayPal or Credit Card—Which is Safer?

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Raise Your Credit Score IQ – take the free quiz now!

Money Girl’s Smart Moves to Grow Rich – get the paperback or ebook!

 

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