Welcome back to our journey through the world of credit scores! In our first article, we laid the foundation by discussing the importance of payment history. Now, let's delve into our second topic: Credit Usage or Utilization—a financial balancing act that can significantly impact your credit score.
Credit Usage or Utilization: Finding the Balance
Imagine your available credit as a safety net, and your credit usage as the tightrope you're walking. Balancing on this tightrope is essential for maintaining a healthy credit score. So, what exactly is credit utilization?
Understanding Credit Utilization: Credit utilization refers to the percentage of your available credit that you're currently using. It's calculated by dividing your outstanding credit card balances by your total credit limit. For example, if you have a credit card with a $1,000 limit and you owe $300, your credit utilization rate is 30%.
Why It Matters: Lenders and credit reporting agencies alike, pay close attention to your credit utilization because it reflects your ability to manage credit responsibly. A high utilization rate signals potential financial strain, while a low rate suggests you're using credit wisely.
The Sweet Spot: Experts recommend keeping your credit utilization below 30% to maintain a good credit score. This means if you have a $10,000 credit limit, try not to carry a balance higher than $3,000. By staying within this threshold, you show lenders that you can manage credit without maxing out your cards. It’s important to note that when I say not to “carry a balance” this means the balance on the day the statement is issued. The statement balance is the balance that is reported to Equifax & TransUnion. Ensure, the outstanding balance PLUS any interest that will be charged, does not exceed 30% of the available credit limit.
Avoiding the Balancing Act Pitfalls: Now, let's talk about pitfalls. Just as in any tightrope performance, there are risks involved. Excessive credit card balances can lead to high utilization, which can lower your credit score. And here's a common misconception: closing a credit card account may seem like a way to reduce temptation, but it can actually increase your credit utilization rate if you have balances on other cards. So, be cautious when making such decisions. This is important for some people like business owners that tend to put a lot of expenses on their credit card. Even though you pay the balance every month, if the statement is issued and the utilization is above 30%, this will have a negative effect on your credit, even if you pay it off montly.
For the Newcomers and Financial Gurus Alike: For those new to the world of finance, this may be an eye-opener. Understanding credit utilization early on can set you on a path to financial success. And for our seasoned clients, it's always good to have a refresher and potentially share this knowledge with family members who are starting their financial journey.
In our quest to crack the credit score code, we're making strides. Your credit utilization rate is like a gauge of your financial stability, and managing it wisely can lead to more favorable lending terms and greater financial flexibility.
Stay tuned for our next installment, where we'll uncover the mysteries behind another credit score factor: Length of Credit History. We'll explore how the age of your credit accounts can influence your financial standing.
Balancing credit for financial success,
Brant Financial Group
