What is Credit Utilization?

What is a good credit score? How do I improve my credit score? This series will go over each credit score factor in depth. Let’s dive in!

A quick note, credit is somewhat mysterious. The exact formulas that Credit Bureaus use to calculate credit scores is not 100% known, though we have the math nearly figured out. Because of this, you may see somewhat arbitrary words like, “High Importance” or, “Low Impact”. These generalize the amount that each area actually impacts our credit score, and give us a moderately close estimate.

Utilization

Credit card utilization, sometimes known as Usage or Amounts Owed, is nothing too complex. It is considered one of the top two or three most important factors in calculating a credit score. To calculate, we simply take our total unpaid balance among all sources of credit and divide by our total credit limit. To maintain a high credit score, it is generally understood that we want this value to stay in the single digits (below 10%). Creditors always strike a tricky balance, and this is one of the biggest areas that is highlighted. Companies that offer sources of credit (banks, credit card companies etc.) want you to carry a balance. That is how they make gobs of money; your interest payments. They will not just give a credit card, though, to someone with a low score in hopes to make this money though. They have to do their best to ensure that the card holder will actually pay the balance (at some point). This is where that balance comes in. It is important to point out that these banks and creditors do not impact your credit score. Their sole goal is to profit off of you.

What credit score is good?

This is where the common misconception that you have to carry a balance comes in. I could go on an entire tangent here about credit misconceptions, but I will refrain. If you are fiscally capable of it, you should never carry a credit card balance. I personally do believe that there is some sort of metric involved that measures whether you use the card at all, but there is absolutely no credit score incentive to carrying a balance. Many credit cards carry interest rates in the 20%-25% range which is insanely high. Do whatever you can to avoid paying even a dime in credit card interest. I will reiterate, carrying a balance in the attempt to increase your credit score is unwise. Even if your score were bumped up a few points (myth) it would not be worth the interest payments. Pay it off in full!

A Quick Note on Compounding

I believe it was Albert Einstein who dubbed compound interest, “the 8th wonder of the world”. I could not agree with him more, but there is something we need to keep in mind with such an incredibly powerful tool.

We want compounding interest on our side!

Powerful forces often work in multiple directions. This is no exception. While compounding can absolutely bring you incredible wealth, it can put you into crippling debt in the exact same breath. Credit cards often carry extremely high interest rates. Sometimes even in the 20%-25% range.

Those are absolutely astronomical rates.

For a quick example, carrying credit card debt at a 25% interest rate for ten years, if you failed to pay anything off, would multiply the amount of credit card debt you have by more than 9 times! Maybe you just had to buy that new couch that you didn’t have the money to pay for. A decade later, in this example, it would be the same as if you went out and bought 9 of them. Crushing high interest debt is so important to financial success.

Sorry for the side tangent here, this information is important to know!

How Do I Improve This Factor?

Don’t you just love math? If you are here reading this you might, but you probably don’t. Fortunately I do. When it comes to fractions, there are two ways to decrease the ending value. Either decrease the numerator (top number, total balance in this case) or increase the denominator (total credit limit).

If we want our credit utilization to go down we either need to pay off some/all of the balance, or we need to increase our total limit. While the first option sounds great, it is not as easy as option two. The two main ways to increase your total credit limit are to:

  • Request a credit limit increase on one or more card(s)

    or

  • Open up a new credit card

I am a big fan of both limit increasing methods and I personally use both all of the time.

An important note, when carrying out the below it is crucial that you begin by asking whether this will result in a hard or soft credit check. Hard checks negatively impact your score (will link the article here once I write it) but soft checks do not. In my experience, this has never resulted in a hard check. If it will result in a hard check, it isn’t worth doing in most cases.

On occasion, your credit card company may just increase your limit. If this happens, that’s awesome! More often than not, they won’t do this regularly. I have a reminder set in my phone, every six months (roughly) you can manually request a credit limit increase. I usually call the company to do this. This call can be intimidating, but don’t let that get to you! The first question will be, “What is your gross annual income?” Answer accurately. Next, they will ask what you would like your new limit to be. This is a tough one, I usually low ball it since I do this so frequently. I like to stay in the 5%-10% increase range, but there are times when you can go well above that.

If you have gotten a raise, promotion, or taken a new job with a higher salary you are a prime candidate for a credit limit increase. I once had a limit on a card double after I took a better paying job.

The answer can sometimes take time, but in most cases they will immediately tell you if your request to increase your credit limit was approved or denied. If denied, don’t get discouraged! As long as there wasn’t a hard check on your credit, you are in the same place that you were before calling, and they will sometimes even give you an ambiguous reason for the denial.

Note, as mentioned above, one of the articles in this series will be on hard vs soft checks. Get excited!

The other option is to simply apply for a new credit card. There are often great bonuses for signing up, and the credit limit of this new card is simply added to your total limit. Increase that denominator! This will almost always result in a hard credit check – something to keep in mind that negatively impacts your score.

Want to read more about improving your credit score? Check out this article on hard credit inquiries!

I hope you found this helpful and I truly appreciate you taking the time to read it! Never hesitate to email me (retirementcalcguy@gmail.com) or DM me on Instagram @retirement_calc_guy !

– RCG