At Credit Karma we like to geek out about one topic a lot: credit scores. We get so excited talking about credit scoring and credit score ranges that you’d think we are talking about the latest Harry Potter movie.
Today, we want to share our geekfest with you. That’s why we’re starting this CuteGeek series all about what goes into calculating your credit score. By knowing what makes up your credit score, you’re better equipped to manage your credit health. Let’s break down one of the six key factors that goes into your credit score: your credit utilization rate. We’ll also talk about what you can do to make sure you’re on the road to continued credit health.
First, a quick overview of credit scores.
What’s a Credit Score?
Your credit score is a three-digit number that affects many areas of your financial life. Lenders use it to determine your creditworthiness, or the likelihood that you’ll pay back your debts in a timely manner.
Each credit bureau (Equifax, Experian and TransUnion) has its own proprietary credit scoring model, but they all essentially take into account these main factors: your credit utilization rate, percent of on-time payments, derogatory marks, average age of your open credit lines, total number of accounts and total number of hard credit inquiries.
Credit Utilization Rate
Your credit utilization rate measures how much of your available credit you’re using and helps lenders determine whether or not you use credit in a healthy manner. You can calculate your credit utilization rate by taking your total credit card balances (how much you’ve charged) and dividing it by your total credit card limits. That percentage is your utilization rate.
A simple calculation. To help you better understand credit utilization rates, let’s take an example. Let’s say you have three credit cards to your name, and each card has a $1,000 credit limit. Your total available credit would be $3,000. If you’ve maxed out one of your cards and charged $200 on another, leaving the third alone, you’re using $1,200 of your available credit, or 40% of your total $3,000 credit limits. That’s your current credit utilization rate.
For credit health: Ideally, your total credit use across all cards should be under 30% of your total available credit; go over 40%, and lenders may see you as less creditworthy. You don’t need to carry over a balance on your credit card from month to month either. To show healthy credit utilization, use your credit responsibly throughout the month and always pay the balances in full. As long as your total credit use is under 30%, even using your card for one small purchase in the month and paying it off at the end of the month is enough to show active, healthy credit use.
Your credit utilization will work to the benefit of your credit score as long as you show active, healthy credit use each and every month. Lenders generally take a look at the past 24 months’ worth of credit activity. Whether you choose to use 5% or 25% of your available credit, responsible credit use can boost your creditworthiness and come in handy when you’re ready to apply for credit or a loan.
Bottom Line: Your credit utilization rate is just one of several factors that make up your credit score. But credit use one of the more important factors, accounting for about a third of your credit score, so be sure to keep an eye on how much credit you’re using from month to month. Keep that usage under 30%, and you’re on your way to good credit health.
Credit Karma™ is a completely free credit management service that provides free credit scores, personalized savings recommendations, and financial education. We believe free access to one’s credit score is a fundamental consumer right. Credit Karma helps more than 3 million consumers realize the everyday cost savings of having a good credit score. Visit us at www.creditkarma.com.
