Are your credit scores stuck, even though you do most of the obvious things right? You pay your bills on time (payment history accounts for 35% of your scores), you don’t often open new accounts (inquiries make up 10% of your scores) and you’re not recovering from a bankruptcy or default. Yet you still struggle to get your credit scores into prime range.
“There is no magic bullet for credit scores. You’ll have to shoot twice,” said Rod Griffin, director of Public Education at Experian. “First, pay on time, every single time. The second bullet is utilization.”
Your credit utilization, and taking steps to lower it, could be the key to better credit scores. (If you’re curious about how you’re doing, you can view two of your credit scores, updated every 14 days, for free on Credit.com.)
What Is Credit Utilization?
Utilization is the amount of debt you have in relation to your total credit limit. So, for example, if you have one credit card with a $1,000 limit and your balance is $500, your utilization is 50%. Credit experts recommend keeping your credit utilization at 30%, ideally 10%, of your total credit limit. (More on that later.)
In most cases, only revolving debts — not debts paid in installments, like mortgages and auto loans — contribute to your utilization ratio. (Find out more about revolving debt here.)
The reason revolving debt counts against your score is that can indicate risk. The credit industry tends to assume consumers who use a higher percentage of their open credit are more likely to fall behind financially.
“A higher utilization rate means a higher risk, which has a greater impact on your credit scores,” Griffin said.
Why Does Credit Utilization Matter?
Credit utilization is a critical element of credit scores, and credit scores lead directly to credit opportunities. Consumers with lower scores won’t qualify for the best credit products available. The credit products that are available to people with lower scores generally have higher interest rates, lower limits and fewer benefits.
“Credit scoring doesn’t look at money. Income and assets, odd as it sounds, have no bearing on whether or not you’ll pay your bills on time. Credit scoring shows the likelihood that the person will pay the debt back as agreed,” Griffin said.
Because of this, it can be very tough to achieve a top credit score if your utilization is very high, even if your debt is low.
How to Lower Utilization & Still Use Your Credit Cards
If you use credit cards, find out when your issuer reports your utilization ration and make sure you pay your balance off beforehand. It can sometimes be before your payment is due each month.
“If you don’t pay before the date the bank reports the information to the credit bureaus, you’ll show a balance,” Griffin said.