23
Oct

Credit Card Utilization Rate

Guest article from BadCredit.org

After charging a recent furniture purchase to my favorite rewards credit card, I was shocked the next time I checked my credit. In just 30 days, my credit score had dropped more than 20 points, all thanks to that one purchase.

How? Well, it all comes down to your credit utilization rate, which is the ratio of your credit card balance over your total available credit. For example, if your credit card has a balance of $500 and a credit limit of $2,000, your credit utilization rate is: $500 / $2,000 = 0.25, or 25%.

In conjunction with your total debt and loan-to-value ratios, your credit card utilization rate accounts for 30% of your FICO credit score. This means that even small changes in your utilization rate can have big impacts on your credit score. As a rule of thumb, many experts suggest keeping your utilization below 30%, but some research suggests a utilization rate around 10% will give you the best results.

Your utilization is one of the easier credit scoring factors to influence, and improving your rate can have some of the quickest results on your score. Since your utilization rate is affected by both your current balances and your total credit limits, you can influence it in several different ways, depending on your financial situation and specific goals.

  1. Pay Down Your Current Balances

Perhaps the most straightforward way to improve your utilization rate, though likely not the easiest, is to pay down your current debt. Your balance is one half of your utilization rate calculation, and the direct relationship between the two values means decreasing your balance is a sure-fire way to decrease your utilization.

If you can’t afford to pay off your existing credit card debt directly, you may be able to get the same results by consolidating your card debt with a personal installment loan. While this won’t provide the same credit boost as actually paying the debt, you may still see an improvement.

Additionally, when done correctly, credit card consolidation can have other associated benefits.

In particular, consolidation can lower your interest rates and make it easier for you to pay off your debt. Indeed, even lenders focused on bad-credit loans can offer lower rates than many subprime credit cards, so you can reduce the size of your monthly payments without taking longer to become debt-free.

  1. Obtain a New Credit Card  

On the other side of your utilization ratio calculation is your available credit, which has an inverse relationship to your utilization rate. This means that as your available credit increases, your utilization rate will actually decrease. As such, another way to improve your overall utilization is to open a new credit card, thus adding to your available credit.

The best part of this particular method for many consumers is that it’s available to most people, regardless of whether they can immediately pay off debt. The biggest impediment to taking this route will be your credit score, as your chances of being approved for a credit card will depend on your creditworthiness. At the same time, options are abundant regardless of your credit score, and finding credit cards for people with bad credit is easier than many assume.

Before applying for new credit cards solely to improve your utilization rate, consumers should consider both the financial and credit costs of a new card. For instance, many credit cards, especially those for poor credit, will charge an annual fee simply for keeping the credit account open. Some cards may also charge program or processing fees to open your account.

Despite the benefit of increased credit availability, your score may actually take a negative hit from your new credit application. This is due to the fact that each time you apply for new credit, the creditor will use a hard credit pull to determine your credit risk.

Hard credit pulls count as part of the new credit factor of your credit score, worth 10% in FICO score calculations. One or two hard pulls will have only limited impacts to your score, but a series of hard credit pulls can cause greater credit damage.

  1. Increase Your Current Card Limits

This is another method of improving your credit utilization rate that relies on the available credit portion of the utilization ratio. However, instead of opening a new credit card to increase your available credit, you simply request a credit limit increase from your existing credit card issuer to get a boost.

The plus side of this particular method is that you get to skip adding additional annual or maintenance fees to your budget. You also avoid making your finances even more complex by adding yet another due date to remember.

At the same time, this method does suffer from one of the same flaws as opening a new card: the hard credit pull. Many credit card issuers will automatically perform a hard credit check when you request a credit limit increase, and, as already mentioned, each hard inquiry can impact your credit score by several points.

You also won’t have any guarantee that requesting an increase will actually work. Credit card issuers are more likely to approve a credit limit increase if you’ve held the card for a long period of time, have maintained your account in good standing, and have shown recent credit or income improvements. Keep in mind that some cards may have built-in credit limit caps that will prevent you from getting an increase regardless of your credit.

A Lower Utilization Rate Means a Higher Credit Score

The effectiveness of any particular method of improving your credit utilization rate — or your credit score in general — will vary with your individual financial situation and credit history. In my case, paying off my furniture purchase allowed my score to quickly rebound from the hit of a high utilization rate.

If your score is being impacted by more than high credit card balances, however, paying down your cards may not have as much impact as you intend. In this case, you should look at the other factors influencing your credit score, including your payment history, which has the biggest impact. You can also consider hiring an experienced credit repair company to help remove inaccurate or unsubstantiated information from your report.

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