Credit Utilization Guide
Credit utilization refers to how much of your available credit you use on a monthly basis. It’s extremely important that your spending not approach your credit limit because FICO—the largest credit scoring agency in the United States—factors credit utilization into its scoring in the form of a balance-to-available-credit ratio, and the lower it is the better. This is one of the most important tenets of credit card use, and failing to adhere to it could lead to lowered credit standing.
Still, there are various myths and misconceptions that mislead consumers and hamper their efforts to use credit responsibly. Because a proper understanding of credit utilization is essential to responsible credit card use, we at WalletHub decided to tackle some of the most important credit utilization questions and expose the facts behind this significant aspect of credit card use.
What does “maxing out a credit card” mean?
You max out a credit card when you spend up to or above your credit limit. This does not mean that your card has been shut down or that you will never be able to use it again. You have simply exhausted your allotment of credit for the current month and must therefore make a payment and free up available credit before making any more purchases with it.
You should avoid maxing out your credit cards unless you have to do so in order to temporarily make ends meet or you plan to repay your full balance (or a large portion of it) right away. Not only do habitually maxed out credit cards indicate unsustainable spending habits and a desperation to borrow, but it’s also bad for your credit standing. Credit scoring companies calculate credit utilization – a ratio of amounts owed vs. available credit – for each one of your credit lines and installment loans individually as well as all of them together. These metrics are included in the Amounts Owed portion of your credit score, which accounts for roughly 30% of your overall standing. The lower your credit utilization, the better, but most experts recommend not allowing it to rise above 30-40%.
Keep in mind that if your current credit limit isn’t high enough to meet your everyday spending needs, you may want to request a credit line increase.
Is getting close to or exceeding my credit limit bad?
Spending that approaches or exceeds your credit limit will negatively affect your credit score unless you are able to reduce your balance before the next billing cycle begins. FICO uses a balance-to-available credit ratio in their credit scoring, and the higher this ratio becomes, the worse it is for your credit standing.
It’s important to note that you need not exhaust your credit completely to incur credit score damage. In fact, it may occur simply as a result of using significant portions of your available credit. Therefore it’s best to use only about a third of the credit available to you. Such spending is viewed as responsible by lenders and credit scorers and will help your credit score rather than place it in jeopardy. However, creditors understand the difficulty of maintaining low utilization when your overall spending limit is low as well and are therefore more understanding about higher utilization ratios (around 60%) in such situations. Someone who has a $400 credit limit could easily exhaust most of their credit line simply by making standard monthly purchases, after all.
Are credit cards viewed individually or collectively for credit utilization?
Both. When FICO calculates your credit utilization it does so for each one of your credit cards individually as well as for all of them in combination. Therefore, it’s best to make sure your spending does not approach your available credit for any of your cards. Still, don’t get too concerned if just one of your cards is highly utilized as long as you have an overall utilization ratio of around 30% and thousands of dollars in available credit.
Exactly how much will high credit utilization hurt my credit score?
You must understand that your credit score is calculated using literally hundreds of variables. While credit utilization is an important factor that is included in a segment comprising 30% of your overall score, it still is just one variable among many. Therefore, you cannot determine the exact impact high credit utilization will have on your credit score because it depends on numerous other factors, including your credit history, how many credit cards you have and how much available credit you have overall. For example, 80% utilization on a single credit card will affect a consumer with little credit history and but one card far more than it will someone with various other credit cards, thousands of dollars of available credit and a long history of responsible credit use.
Obviously, 100% credit utilization will damage your credit more so than 80% utilization. Having numerous fully utilized cards and prolonged high credit utilization will both be particularly damaging as well. However, credit utilization cannot be viewed in a vacuum. In the end, maintaining low utilization can only help you. But remember not to get bogged down in any one aspect of your credit score; focus on the big picture.
Will paying my full balance each month hurt my credit score?
Though it’s rumored that credit card companies view customers who pay their balances in full each month unfavorably because it precludes them from charging interest, this is but a mere myth. Failing to pay your balance in full does not result in garnering the favor of your creditors; it only leads to increased costs because of interest.
You can check your credit score, and ultimately gauge the impact of your actions, by ordering a free score from one of the numerous online providers.
How can I lower my credit utilization?
There are three ways to lower your credit utilization. First, you can increase your available credit. There are various ways to do this, but if you lack excellent credit, the easiest way to do so might be opening a secured credit card and adding to its security deposit over time. Secondly, you can make credit card payments more than once a month so that your balance never gets too high. Finally, splitting your spending between two credit cards will result in two cards with low credit utilization rather than one with relatively high utilization.
Do any credit cards make it difficult to maintain low credit utilization?
You must know what your credit limit is in order to avoid high credit utilization. If you don’t, how can you make sure that your spending stays well below it? Therefore, you should avoid No Preset Spending Limit (NPSL) cards. Many people open NPSL cards like the Visa Signature credit card, the World MasterCard credit card and American Express charge cards under the impression that they provide unlimited spending capabilities. However, these cards do have limits; they are just not released to either consumers or the credit bureaus so that the lucrative myth of unlimited spending may be maintained. As a result, NPSL card users are left with both the increased likelihood that their cards will get unexpectedly declined and the potential for accidentally high credit utilization. The latter generally occurs either because a consumer has no way to keep spending below a limit about which he is unaware or because the available credit provided by some NPSL cards (such as the AmEx charge cards) is reported to the credit bureaus in such a way that it is ignored by FICO, thereby effectively lowering the amount of available credit one has overall.
Image: Janos Levente /Shutterstock
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