When I work with clients to harness their cash flow, the discussion often turns to how they use their credit cards, and the impact of that on their credit scores. Not all of us know exactly what is a credit score nor how is it impacted by the use of plastic. A credit score is a numerical value calculated from information in your credit file that is used by lenders and landlords to assess your “credit risk” at that time. A credit report is a summary of your financial reliability—for the most part, your history of paying debts and other bills.
Do you know exactly how your credit score is determined? Click here to see:
Should you use your credit cards at all, or to what degree, if you want to achieve/maintain a good credit score?
As a large part of your credit score (30%) is based on how much of your available credit you’re using. This ratio of credit card balances to credit limits is known as your credit utilization. The higher your credit utilization, or the closer your credit card balances are to your credit limit, the more your credit score is hurt. Most experts will tell you to keep your ratio below 30%. This rule is helpful because it gives you a reasonable goal and data shows that the lower your ratio is, the higher your credit score will be.
Note that your credit score is composed of a number of factors. If your overall credit profile is in excellent condition, it’s unlikely that your credit score will plunge if your credit utilization ratio rises to 31% one month. But if you occasionally miss payments, have too many inquiries on your credit report or are new to credit, then utilizing more than 30% of your available credit will likely have a more harmful effect on your score.
It’s also important to keep in mind that your utilization rate is the percentage of credit you’re using across ALL of your credit cards. In other words, your utilization is calculated by totaling all of the balances you carry across each credit card you own — you don’t have a separate utilization rate for each card.
So if you’re carrying a $2,000 balance across three credit cards with a total available balance of $6,000, your utilization rate is 33 percent – even if you’re using 50 percent of one card’s limit and 10 percent of the other cards’ limits.
You can improve your score in this not so intuitive way:
Ask your card issuer for a credit limit increase: getting a credit limit increase can be a great way to lower your utilization with limited effort on your part. And if you’ve used credit responsibly until now, there’s a good shot they will grant your request. Once you get that bigger credit line, remember not to increase your spending as well, or else you could negate the positive effects of having a larger limit.
Be sure to use your credit cards at least a bit. Although keeping your utilization at zero percent might seem like the best way to go, banks may actually frown on it. Remember, they want to see that you’re using credit responsibly – not avoiding it altogether.