Understanding Credit Utilization – Ever wondered why your FICO score is not as much as you thought it would be?A greater credit score would allow you to take bigger loans in future for a house or for refinance if you ever decided to.In order to do this,you need to have an impressive credit report.
I have been working in credit card collections for sometime now,and here are a few things about credit utilization that many people do not bother to understand while incessantly using their cards everywhere and anywhere .
What is Credit Utilization – It is the amount you use on your credit card vs the limit on the card – For example if your set credit limit is $500 and you use $250,then your credit utilization is 50%.
In other words it is a ratio like so : Amount spent on card / Credit Limit * 100 = Credit Utilization.
Now you may think,why it this relevant and so important?
When you use the FICO or Vantage credit score checker it will generate your credit score based on history of past payments,how long you have collected that credit,how much debt you have and lastly Credit Utilization. Out of these factors,credit Utilization can account for anywhere between 30-35% of your credit score.Meaning, it is a major contributing factor that goes into play while calculating a score.
How can high credit utilization affect you
When you have more than 30% credit utilization it could possibly have a negative influence on your credit score.You need to use less than 30% and that that balance below this mark by continuously paying off more than that minimum due each month.Having a negative influence on your credit score is just one of the affects of high utilization,others are:
- Increased interest charges – The higher the balance you keep,the higher the interest charges there will be each month for you to pay.With interest charges at more than 25% APR, you will be paying more interest than spending on your card.
- The higher credit utilization means lesser credit you can enjoy and will give you lesser amount to spend on your card for purchases
- High credit utilization will eventually dig you deeper into debt,and as a result,you will fall back on payments,and eventually you will incur fees and charges that will further more add to your misery and increase the credit utilization.
Effects of Low Credit Utilization
Just like i showed you above are the ways by which having an increased Credit Utilization can eventually cause you financial havoc,here are a few ways to keep a low credit utilization:
- Always make it a point to clear off more than the minimum due amount every month. infact you can go a step ahead and clear atleast one quarter of purchases you made on that card in the month.That will ensure a reduced and sustained card balance.
- Keep the card balance always at 25% of the total limit.This means if your limit is $1000,then dont allow the card balance to go past $250,and work to maintain this equation.
How can you lower your Credit Utilization
One simple way you my think is to just keep a tab on how much you spend and dont cross that 30% mark.
Pay off more than minimum due every month before the due date
Concept of 0 Credit Utilization
Another great way to do this is to keep in mind your billing cycle,date the bill is generated and the due date.Now try and time your purchases exactly after the bill is generated for the current billing cycle.This way you will have atleast 45 days grace period to pay off this amount you used.You can also clear off the entire balance and start clear with a 0 credit utilization.
What are the benefits of this? – The first thing is by continuously keeping a 0 credit utilization,yo will incur absolutely no interest charges and second most importantly – it will look wonderful on your credit report and also will show that you have excellent repaying capacity,thereby increasing your chances of enhanced credit limits in future as well as a higher credit score.You will also be approved easily for any loans later on in life.