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Understanding Credit Card Utilization and Its Impact on Your Credit Score

Credit card utilization is a crucial factor in determining your credit score. It refers to the amount of credit you’re using compared to your total credit limit. High credit card utilization can negatively impact your credit score, but there are ways to manage and improve it. In this article, we’ll explore how credit card utilization affects your credit score and provide tips to help you keep it low.

How Long Does High Credit Card Utilization Impact Your Credit Score?

High credit card utilization can affect your credit score as long as your balances remain high. Once you pay down your balances and your card issuer reports the lower utilization to the credit bureaus, you could see a positive effect on your scores in as little as 30 days. However, some newer credit scoring models, such as VantageScore® 4.0 and FICO® 10 T Score, use trended data, which includes utilization data from up to 24 months ago. This means that even if you pay off your credit card debt all at once, a history of high balances can still impact your credit score.

How Credit Utilization Rate Affects Credit Scores

Credit card utilization is a significant factor in calculating the “amounts owed” portion of your FICO® Score, which makes up about 30% of the score. FICO® Scores are used by 90% of top lenders, making it an important consideration. You can calculate your credit card utilization by dividing your card’s balance by its credit limit. Similarly, overall credit utilization is the sum of your total credit card debt across all cards divided by the sum of your credit card limits and multiplied by 100.

Example of Credit Utilization Calculation

Let’s say you have a retail credit card with a credit limit of $300, and you charge $150 worth of merchandise. You now have a credit card utilization rate of 50%—well above the recommended 30% ceiling. If you have a second credit card with a credit limit of $5,000 and a typical monthly balance of $150, the utilization on that card is just 3%. Overall utilization would be slightly less than 6%, which is an excellent rate.

Tips for Decreasing Your Credit Utilization Rate

Whether a score algorithm uses the most recent balance reported or trended data, keeping your balances low relative to credit limits can help your credit score. Here are some tips to get and keep your credit card utilization low:

Pay Down Credit Card Balances

Lower balances relative to credit limits translate into lower credit utilization. Enact a plan to pay off your credit cards, and your scores will likely improve over time.

Ask for a Credit Limit Increase

This works best if the credit card is not brand new or if your income has increased. It may also result in a hard inquiry on your credit report, which could ding your score by a few points. Before you ask your card issuer for a limit increase, check your credit score.

Apply for a New Credit Card

A new card will increase your overall credit limit. If your credit card debt does not change, that can help reduce your utilization.

Consolidate Your Credit Card Debt

A debt consolidation loan could help you lower your credit card utilization by reducing the amount you owe on credit cards. However, you still owe about the same amount of money. Another advantage of a debt consolidation loan is you may pay less interest on what you owe. Just be sure you don’t run up your credit card balances after taking on the loan, or you could end up in a worse situation.

Keep Credit Cards Open

Unless you have a compelling reason to close your credit card accounts, keep them open. They contribute to both your overall credit limits and the average age of your credit accounts, a minor factor in your credit score. If you are trying to avoid an annual fee, ask the issuer if you can switch to a card that doesn’t have one.

Consider Paying Early

If a low credit limit results in high utilization, consider paying early. Once a charge posts, you can typically pay it off online. You don’t have to wait for a statement, and paying early can help you avoid a high utilization on your credit report.

The Bottom Line

With most credit scores, any damage from high credit card utilization goes away when credit bureaus have up-to-date information on your new, lower balances. However, it’s still smart to make a habit of keeping balances relatively low. Newer scores using trended data look back at up to 24 months’ worth of balances and payments, so routinely controlling the balances can be smart. The use of trended data also means that a spike in balances that occurs in a pattern (such as during the holidays) won’t have as much impact.

At O1ne Mortgage, we understand the importance of maintaining a good credit score, especially when it comes to securing a mortgage. If you have any questions or need assistance with your mortgage needs, don’t hesitate to call us at 213-732-3074. Our team of experts is here to help you every step of the way.

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