One thing most people try to understand is how your credit score is calculated. After all, credit scores can be influential to mostly everything in life.
It is known that credit card utilization is one of the most important factors credit scoring models use to calculate your credit score. You can figure out your utilization rate by dividing your total credit card balances by your total credit card limits.
To illustrate how important this factor is, I’ve found and resumed here a graphic doing a relationship of possible credit scores and corresponding credit card utilization rates.
This graph above suggests that there is a strong correlation between credit card utilization rates and credit scores. Generally, those who had a lower utilization rate had a higher score and vice versa – with an exception for those with 0 percent utilization. The average credit score of those who had a utilization rate of 0 percent was actually lower than the average score of those who had a utilization rate of 1-20%.
So What Does This Mean?
Lenders don’t like high utilization rates because it tends to indicate there’s a higher chance of you not being able to repay your debts. Keeping your credit card utilization low, preferably under 30%, is a good goal to aim for. Data suggests an even better goal is to use your credit some, but keep the utilization rate under 20%. Creditors want to see proof that you can manage credit wisely–something you can’t do without using the credit you’re granted.
In other words, if you keep cards open and payoff entire balance each month, your reported usage might be zero which apparently is something not desired as it might demonstrate no usage of credit thus no knowledge in how to manage credit wisely.
If you’re uncomfortable with the idea of using your card for large purchases, you can still show an active credit profile by paying for small items with your card. It’s important that you practice good habits when managing your credit cards. Charge what you can pay back and make sure your payments are on time. Again, in order to keep your utilization rate greater than 0%, you’ll need to let your charges show up on your billing statement, and then you can pay it off in full. This does not mean you need to carry a balance from one month to the next–doing so may just cost you money in the form of interest.
I did had the same mistake for several months, trying to payoff all my bills and card balances even before they were actually posted on a statement to become due. Therefore they were never showing on statements and dragging my credit lower. Now I’m fixing this mistake and sharing the tip here with my followers.