Why Credit Utilization Matters?
Your credit score is almost like your daily cuppa coffee.
Every morning, you take the time to put together a steaming, just-perfect, sweet enough, cup. Measuring, tasting, adding, and pouring, until it is worthy of being consumed.
Same goes for your score. Everyday, you analyze the factors that make up your score. Does it look good? What boosted my score, what knocked it down? You’re on Credit Karma, Credit Journey, or whatever other app you use to monitor your credit, on a daily basis, making sure your credit score is just so.
And like we each know so well what makes up our desired coffee, (Grandma won’t do without the sugar cube melting in her mouth as she sips, while brother will never skip the 2 packs of Splenda, and all the while, your sister will say there’s nothing like the cafe’s capp), it’s just as important to know what makes up a desired credit score.
There are 5 factors that make up your credit score. One of them, credit utilization, is an essential factor for a perfect score, and here’s why.
Where does credit utilization fall in
There are 5 factors that are the main powers in making up your Fico credit score: coffee, sugar, hot water, milk, froth.
Caught you there!;)
The 5 factors are:
- On-time payments- 35%
This will include late payments, missed payments, charge offs, collections. Making on-time payments for credit cards, loans, and leases, is what’s good for your score.
- Amount owed- 30%
Amount owed calculates the balances you have on each of your credit card accounts, but most importantly, how much of your credit availability you use on each account, aka credit utilization, with the less of your credit availability used, the better. Credit utilization is only looked after on revolving loans, those are credit card accounts, and not other types of loans or leases.
- Credit history – 15%
Credit history calculates how far back you opened up your first credit card. The longer ago, the better. That’s why it’s best to start building credit as soon as you turn 18, and to keep your first couple of credit cards open forever so that your credit history is as old as can be.
- Credit mix- 10%
Having a mix of revolving loans (credit cards with fluctuating fees), and installment accounts (loans with set fees), is having a good credit mix. So bring on the credit cards, leases, mortgages, loans…
- New credit – 10%
Anytime you open up a new account, your score will drop. But it will go back up shortly after. So just beware and don’t panic when that happens because it’s both inevitable and temporary.
What is credit utilization and why credit utilization matters
So what’s the big, 30% deal on credit utilization?
I’d say credit utilization is like the hot water in your coffee, with on-time payments being the coffee granules.
Without the coffee granules, there’s no coffee, but would you bear drinking a cup of undissolved coffee bits?
So credit utilization is almost as effective as on-time payments.
How do you know what your credit utilization is?
Credit utilization is how much percent of your credit limit you use. So let’s say you have a credit card with a $1,500 credit limit. You use the card to swipe $500 for a new, robot vacuum. Ta-da, you just used 33% of your credit limit.
You then take your second credit card which has a credit limit of $8,500, and get the same, $500 robot vacuum for your friend (who saw the vacuum at your place and asked you to pick one up for him too. That’s what friends are all about). After the purchase, your second credit card has a credit utilization of a bit over 5%.
Hey, you exclaim! It’s the same item! Same price! Yes, but the credit availability on the second card is higher than that on the first card. That’s why the same $500 has a smaller effect on your second card than it has on your first.
That’s why credit utilization matters. It’s not about how much you spend. It’s about how responsible you act according to the funds you have available.
Credit utilization is never calculated by dollars as we’ve seen, only by percentage.
Keeping your credit utilization low and slow will keep your score up.
How is credit utilization calculated
Since it works by percentage, credit utilization varies from 0% to 100% and over.
The numbers are split into brackets. Following is an assumption of what the brackets are, (only Fico has the exact numbers).
Bracket 1: 0%-9%
Bracket 2: 9.1%-29%
Bracket 3: 29.1%-49%
Bracket 4: 49.1%-79%
Bracket 5: 79.1%-100%
Bracket 6: 100% or more
Best is to be in bracket 1. That would mean keeping your credit card balance at less than 9% of your credit limit. Once your balance hits 9.1%, it’s already considered bracket 2. The higher a bracket your balance is in, the less good your credit utilization is.
But, a credit utilization of 0% is also not good. That would just look like your card is inactive, and may cause for it to be shut down after a few months.
How to fix your credit utilization
The good thing about credit utilization, and what makes it nice that it accounts for so much of your credit score, is that it’s easy to fix and get back into the best credit utilization bracket.
All you have to do in order to lower your credit utilization, is pay your balance down to 9% of it’s credit limit.
Once you pay and the balance is updated with the credit bureaus, your credit utilization will have been repaired and your score will go back up.
Conclusion
What makes up your credit score is not the same as what makes up your coffee, but like every ingredient in your coffee makes a difference, so do the factors making up your credit score.
Credit utilization is one of the 5 factors that have an affect on your credit score, and credit utilization matters!