What is Credit Usage? How Does It Affect My Credit Score?

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Credit cards open a way for us to make payments safely and efficiently. First, it saves you from the hazard of theft since you will not need to carry thousands of money anymore to buy that furniture you need for your house. You only need to secure your card with you, swipe it on the cashier, place your signature, and viola, now you have your furniture! Second, it allows you to buy immediate things you need even if you do not have the means to pay them yet. Third, it is more time-efficient compared when you have to save money and spend it in one go.

However, it also has its own warning signs. A high credit utilization may result in a low credit score and high difficulty in making large payments. More so, if in any case you made a late payment, you will incur higher interest rates. Credit utilization or usage is very important when it comes to balancing your credit and in this article, you will know what it is, how it works, how does it affect your credit score, and some helpful ways to  manage it  correctly.

What is Credit Usage?

Credit usage or utilization is the ratio of your current credit balances, on both lines of credit and credit cards, relative to your overall credit limit on all of your accounts. It is the percentage of the total available credit that you have used or utilized. It is one of the most relevant factors that affects your credit score calculation.

How is It Being Calculated?

First example, let’s say you only have a single credit account and its credit limit is $1,000. If you have an outstanding balance of $400, then your credit utilization is 40%.

Taking it to another level, for example you have three (3) credit cards with the following outstanding balances and credit limit:

CREDIT CARD OUTSTANDING BALANCE CREDIT LIMIT
A $1,500 $5,000
B $2,500 $8,000
C $5,000 $10,000

 

Adding up the credit limit in all accounts, your total credit limit is $23,000.

Meanwhile, your total outstanding balance is $10,000.

CREDIT CARD OUTSTANDING BALANCE CREDIT LIMIT
A $1,500 $5,000
B 2,500 8,000
C 5,000 10,000
Total Credit Limit $23,000
Total Outstanding Balance $10,000

Computing for the credit utilization ratio, we divide your total outstanding balance against your total credit limit and express it as a percentage: [(10,000/23,000)*100%]. Therefore, our credit utilization ratio is 43.48%.

CREDIT CARD OUTSTANDING BALANCE CREDIT LIMIT
A $1,500 $5,000
B 2,500 8,000
C 5,000 10,000
Total Credit Limit $23,000
Total Outstanding Balance $10,000
Credit Utilization Ratio 43.48%

The lower the credit utilization percentage, the better, because it will tell that you are only using a small part of credit that is being lent to you. Moreover, this is being used by agencies in calculating your credit score. So a lower ratio is better.

How Does It Affect Your Credit Score?

Currently, we have three (3) credit bureaus that process our credit data: Experian, TransUnion, and Equifax. Although these three cater to different purposes, they have something in common and that is the FICO Credit Score.

It has an algorithm that is being used by the 3 bureaus and sums all information gathered into a 3-digit number from 350-800, which is the credit score. This 3-digit number is very important since it will represent your creditworthiness as a borrower and will tell your debtors on whether you can pay them back or not. It has five (5) factors to consider namely the amounts owed, payment history, new credit, length of credit history, and credit mix. It will be a long journey to discuss each but it will boil down to a single thought when it comes to credit utilization.

Repeating it once more, your ratio shows how much credit you use from that of which you are available. Meaning, if you have a high ratio, this will more likely show that you will have a hard time paying back your loans since you already have so much to pay first. And it is the same case when you have no credit utilization ratio either. Data tells us that the best number would be lower than 20% and not more than 30%, but not 0%.

How to Get The Perfect Ratio?

While it may be promising to hear that sweet spot range, it is indeed difficult, but very possible to achieve, especially if you are firm to your goal. To provide you with help, here are some tips that you can follow through:

 1.) Be aware of how much you are using on all of your credit cards.

Monitor them carefully and regularly. Never overspend and especially go beyond your limit. Keep your balances low on all accounts at all times.

2.) Request for a higher credit limit.

If you will assess the math of the ratio, notice that it is very dependent on the credit limit, so why not grab the chance and increase it? This is a very helpful way especially if you are in good terms with your card issuer, and more so if you are not spending too much always.

3.) Pay regularly.

Pay all your balances in all your accounts every month. If it is still not the end of the month and your percentage is starting to go higher than 30%, pay still. If you are busy and do not have the luxury to check and compute once in a while, you may use a balance alert to monitor it.

Always remember: the lower your credit utilization is, the better. And while it may take awhile to better your credit score, make sure you do the three (3) tips we have given you. Above all else, make sure to practice balance, patience, and good borrowing habits.

References

Irby, L. (2020 June 7). Understanding Credit Utilization. Retrieved September 29, 2020 from: https://www.thebalance.com/understanding-credit-utilization-960451

Kagan, J. (2020 August 5). Credit Utilization Ratio. Retrieved September 29, 2020 from: https://www.investopedia.com/terms/c/credit-utilization-rate.asp

Mclntyre, G. (2020 August 24). Credit Utilization: What It Is and How to Optimize for It. Retrieved September 29, 2020 from: https://www.fundera.com/blog/credit-utilization

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