Credit Score Factor: Credit Card Utilization
Intro
In the first lesson we looked at a high-level overview of the credit score. In this section we will begin digging into one of the factors that affects your credit score: Credit Card Utilization.
We will go over what this term means, how it actually affects your score and tips for how you can take action to use it in your favor.
What is Credit Card Utilization?
When you open up a new credit card, you are given a set limit of credit from a financial institution that you can use over a period of time.
In most cases, this period of time is one month. For instance, when I opened up my first credit card through Chase I was given a $5,000 credit line. I could borrow up to $5,000 from Chase during a 1 month time frame.
In simple terms, your credit card utilization is how much of your available credit you have used at any given time.
If on the day I opened the Chase card I decided to go to the mall and buy a $5,000 Gucci belt with my credit card, then my credit card utilization would be at 100%…and I’d probably get some weird looks around the office.
Why Lenders Care
Recall that the primary purpose of a credit score is to judge creditworthiness, or how likely you are to pay back your loans.
In the eyes of a lender, a person who uses a high percentage of their allotted credit, is likely overextending themselves and may struggle to pay off credit card and loan balances.
Even if you still pay off your card in full each month, high utilization can still be a sign of risk to lenders.
The reason? You aren’t leaving much room for error and are more likely to default on payments or struggle if anything goes wrong in the future.
On the flip side, a low credit utilization rate signals to lenders that you can use credit responsibility without becoming overly reliant on it.
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