Understanding Credit Score Factors and Credit Utilization
To begin, it is important to understand the factors that go in to a consumer’s credit score. There are five major factors and each factor is weighted differently. Here is an approximate summary from FICO explaining the primary credit score factors:
The following five factors will impact your credit:
- Amount Owed On Revolving Credit (Credit Utilization)
- Consumer Payment History
- New Lines of Credit On Your Account
- The Length of your Credit History
- The composition of your credit (mortgages, student loans, credit cards, etc.)
Looking in to these five factors, you will realize that there is only one category that consumers have significant control of – Amount Owed/Credit Utilization. Payment history is a thing of your past. Consumers can (and should!) make sure future payments are made on time, but there is no control over past payments. The length of your credit is another factor consumers have no control of. New Credit and Credit Mix are categories people have some control of, but very few people will get a car loan to “diversify” their credit mix. Nor would this be recommended. This leaves one final category – credit utilization. This is frequently reported as the second largest factor to credit scores and it also happens to be the one that consumers have the most control of. Let’s explore how you can use this to your advantage!
For More Information About Getting Your Free Credit Score Online Check Out This Article Comparing Two Of The Most Popular Free Credit Score Trackers – Credit Sesame and Credit Karma!
What Is Credit Utilization?
Simply put, Credit Utilization is the amount you owe on your credit cards relative to your total credit limit. The less you owe, the lower your credit utilization percentage is. Alternatively, and very important, the higher your total line of credit is, the lower your utilization will be. When it comes to credit utilization, lower is better! Let’s take a look at the following example:
- Credit Card 1 has a limit of $10,000
- Credit Card 2 has a limit of $5,000
- Card 1 has a balance of $5,000
- Card 2 has a balance of $2,500
The total credit for this individual would be $15,000 (Card 1 limit + Card 2 limit). The total owed would be $7,500 (Card 1 balance + Card 2 balance). This person would have a credit utilization of 50%. If this individual paid off half of their balance on each card, their utilization would drop to 25%. Consumers should aim for a credit utilization of less than 30%, but keep in mind that lower is always better! Now, let’s say that instead of paying off their balance, this same individual contacted their credit card companies and requested an increase in their lines of credit. The new scenario is as follows after receiving a credit line increase:
- Credit Card 1 has a limit of $15,000
- Credit Card 2 has a limit of $10,000
- Card 1 has a balance of $5,000
- Card 2 has a balance of $2,500
Without paying off any debt, this same consumer would now have a credit utilization of 30% ($7,500/$25,000). As you can see, there are two ways to decrease your credit utilization: reduce your balance OR (and better yet, AND) increase your total line of credit.
How To Optimize Your Credit Utilization?
The main goal that people should have in mind is to never exceed a utilization percentage above 30%. For individuals who use their credit card for all of their expenses, this may not always be an easy option. In a perfect world, consumers should always pay off their card in full with each statement. This will essentially keep your utilization at zero. Even if you have a large balance between statements, you will not see significant fluctuation in your score if your balance is paid in full each month. With this said, it is important to realize that many people use their credit cards to finance large purchases – this is just a reality of life.
One of the greatest credit hacks is to regularly request credit line increases with all of your credit card issuers. Credit Card issuers are happy to increase your credit line for responsible customers. Factors that will impact whether you are approved for a credit increase include:
- Keep a low credit card balance
- Always make your payments on time
- Do not have other cards that are “maxed out”
- Other credit accounts (such as loans) are up to date
Requesting Credit Line Increases
Major credit card issuers including, Discover and Citi, allow consumers to check for credit line increases online. Often time, there is not hard credit inquiry necessary. These should be taken advantage of every time they are available. Some other credit card issuers like Chase will require you to contact them by phone and request an increase (more on Chase Credit Line Increases here). You will be informed beforehand whether a hard credit check will be necessary. There is a balance in this process. Too many credit inquiries can be a negative on a credit report. However, credit inquiries are a far smaller portion of your score than utilization so most consumers should feel free to request limit increases annually.
While increasing your line of credit is an extremely powerful tool to increase your credit score, it is important to remember that the ideal circumstance is to never charge more than you can pay off in a given month. If you have an existing balance, consumers need to work hard to reduce their balance as aggressively as they can afford.
As a side note, at the time of writing this article I decided to check my Discover IT Card to see if it was available for a line of credit increase. After entering my income, liquid assets, and employer I was approved for a credit line increase with no credit check whatsoever!
How Much Can Proper Credit Utilization Impact Your Score?
This is a difficult question to answer. There additional factors within the 5 main categories outlined in this article. FICO does not release the exact details of how consumer credit scores are calculated. However, we do know that credit utilization is the single biggest factor that you have direct control over. Anecdotal reports vary, but consumers consistently report significant decreases to their score when they exceed the recommended 30% utilization. Conversely, consumers report significant increases to their score when they lower their high credit utilization. Overtime, proper credit utilization management can easily swing a credit score by 100 points.
Actions You Can Do Today To Increase Your Score (And Decrease Your Credit Utilization)
- Check all of your cards for a no credit check credit line increase
- Determine if you should request an increase with a credit check (advised only for consumers who are likely to be approved)
- Lower your existing balances – stop charging to your card until your balance is under control
- Set up a payment plan to reduce your balances in a budget friendly manner
All of the above actions will have immediate impacts to your credit score. Even decreasing your balance by a small amount can result in big credit increases. In addition to these actions, consumers should always live by smart credit management rules.
Should You Open A New Credit Card To Increase Your Total Line of Credit?
The average American consumer has 2 or more credit cards. Some surveys have even shown that more credit cards actually correlates with an increased credit score. This makes some sense in that consumers with more cards would also have a very low credit utilization. Overall, the biggest thing a consumer should consider is whether or not they will use a new card responsibly. For responsible consumers, getting a new credit card is a great way to increase your total credit line. Several factors to consider when looking for a new card include:
- What type of credit card are you looking for (cash back, travel, etc)
- Is there a particular company that you want to do business with (an airline or store card)
- Consider credit card sign up bonuses – these are often great opportunities for free rewards
For More Information About Getting A New Credit Card – Check Out These Articles!
- Why Cash Back Credit Cards Suck (For Consumers Who Want More Than Cash Rewards!)
- The Best Cash Back Credit Cards – The Ultimate Guide
- Credit Cards For Fair Credit (For Consumers Who May Not Have Stellar Credit)
- Best Credit Cards For Bad Credit (Cards Designed For Individuals With Poor Credit Histories)
A Quick Recap – Credit Utilization
Credit Utilization is the single biggest factor of your credit score that you have complete control over. It is a percentage based on your current credit card balances compared to your total credit limit (for all cards – balances and limits). Keeping your utilization below 30% will greatly impact your score for the better. Paying down your balances and regularly requesting credit line increases are easy ways to lower your credit utilization. Finally, credit cards should be seen as a financial tool used for convenience and security. Cards should not be considered a good option for financing purchases due to very high interest rates.
Let us know your best credit score hacks in the comments below!