Credit card utilization is among the most important factors in building your credit score.
While many people understand the basics and importance of maintaining a good credit score, such as paying bills on time and using credit cards, others don’t.
Through this article, I will try to make you understand what credit card utilization is, why it’s important for your credit score, and how you can manage it effectively.
By the end of this article, you’ll have a clear understanding of how to use your credit cards wisely to keep your credit score in good condition.
What is Credit Card Utilization?
Credit card utilization is the ratio of your current credit card balances (Credit card bills) to your total credit limit, expressed as a percentage.
For example, if you have a total credit limit of INR 1,00,000 across all your credit cards and your total balance is INR 20,000, your credit card utilization rate is 20%.
This percentage is a key factor in determining your credit score. The lower your credit card utilization, the better it is for your credit score.
Most experts recommend keeping your utilization rate below 30%, but the lower, the better.
Why Credit Card Utilization Matters
Credit card utilization matters because it directly impacts your credit score. Credit bureaus view a high utilization rate as a sign that you may be over-dependent on credit, which could make you a riskier borrower.
On the other hand, a low utilization rate suggests that you are managing your credit responsibly, which can positively impact your credit score.
How Credit Card Utilization Affects Your Credit Score
Credit card utilization is one of the major factors that credit bureaus consider when calculating your credit score. Here’s how it works:
Credit Scoring Models: Credit scoring models like Transunion CIBIL, Experian, FICO and VantageScore heavily weigh credit card utilization. Typically, it accounts for around 30% of your overall credit score.
Risk Indicator: High credit card utilization can signal to lenders that you are over-relying on credit, which may indicate financial stress. This can lower your credit score as lenders might view you as a riskier borrower.
Creditworthiness: A low credit utilization rate suggests that you are managing your credit responsibly and aren’t maxing out your credit cards, which is viewed positively by lenders.
Ideal Credit Card Utilization Rate
While a utilization rate below 30% is generally considered good, aiming for a lower percentage can have even more positive effects on your credit score. Here’s why:
0% Utilization: Having a 0% utilization rate, which means you’re not carrying any balance on your credit cards, is ideal but not always realistic. It shows lenders that you are not dependent on credit.
1-10% Utilization: This range is often seen as optimal. It shows that you’re using credit but are doing so in a very controlled and responsible manner.
11-30% Utilization: This is generally considered safe and won’t negatively impact your credit score. However, staying closer to the lower end of this range is advisable.
How To Manage Credit Cards Effectively?
Managing your credit card utilization is crucial for maintaining or improving your credit score. Here are some practical tips:
Pay Off Balances Early: If you can, pay off your balances before the statement closing date. This way, a lower balance is reported to the credit bureaus, which can help reduce your utilization rate.
Increase Your Credit Limit: If you’re disciplined with your spending, requesting a credit limit increase can help lower your utilization rate. However, avoid the temptation to increase your spending just because your limit is higher.
Distribute Balances: If you have multiple credit cards, try to spread your balances across them instead of maxing out one card. This can help keep your utilization rate lower on each card.
Make Multiple Payments: Consider making multiple payments throughout the month to keep your balance low. This can help manage your utilization rate effectively, especially if you use your credit card frequently.
Monitor Your Credit Report: Regularly check your credit report to ensure that your credit utilization is being reported accurately. Mistakes can happen, and if your utilization is reported incorrectly, it could negatively impact your credit score.
Remember while using Credit cards, utilization is a critical factor in maintaining a healthy credit score.
By understanding how it works and managing it effectively, you can avoid the pitfalls of high utilization and keep your credit score in good shape.
Your goal should be to keep your utilization rate low, ideally below 30%, but the lower, the better.
By following the tips shared in this article, you can take control of your credit card usage and make it work to your advantage.
Some Important FAQs:———————
What is a good credit card utilization?
A good credit card utilization rate is generally below 30%. However, the lower your utilization, the better it is for your credit score. Ideally, aim for a utilization rate between 1% and 10%.
What is credit card 30% utilization?
30% utilization means that you are using 30% of your total available credit. For example, if your total credit limit is INR 1,00,000, and your current balance is 30,000, your utilization rate is 30%.
This is generally the maximum recommended utilization rate to avoid negatively impacting your credit score.
What happens if I use 90% of my credit card?
Using 90% of your credit card limit is considered very high and can significantly lower your credit score. It signals to lenders that you might be overextended and heavily reliant on credit, which increases your perceived risk as a borrower.
Is 40% credit utilization bad?
A 40% credit utilization rate is higher than recommended and may start to negatively affect your credit score. It’s best to aim for a utilization rate below 30% to maintain a healthy credit score.
Can I use 80% of my credit limit?
Using 80% of your credit limit is quite high and can negatively impact your credit score. It’s advisable to keep your utilization rate below 30% to avoid any adverse effects on your credit score.
What is the 5/24 rule?
The 5/24 rule is a guideline used by Chase Bank (USA). It states that if you have opened five or more credit card accounts (with any issuer) in the last 24 months, you will likely be denied a new Chase credit card.
This rule is important to keep in mind when applying for new credit, as it can affect your approval chances.
Does closing a credit card affect my utilization?
Yes, closing a credit card can affect your credit utilization rate. When you close a credit card, you reduce your total available credit, which can increase your overall utilization rate if you have balances on other cards.
It’s important to consider this before closing an account, especially if you’re carrying balances on other credit cards.
How often is credit card utilization reported?
Credit card utilization is usually reported to the credit bureaus once a month, around the time your statement is generated. However, this can vary depending on the credit card issuer.
I think the best way to manage cards is to keep less cards with high limit. You can use any card for anything and still know about the spending and time to pay the bill. Instead of using 12 cards with $2-3K each use 4 cards with a limit of $20K each.