June 26, 2019
This is the second of a 5-part series covering the factors that are used to determine your credit score.
In this segment, I am going to go over the second most important part of your credit. And you may be surprised to find out that it has nothing to do with your house payment or your car payment (which are probably the two most important payments to you).
The subject of this post is your credit cards. To be more specific, it is your credit card balances. Technically, it is actually based on your “revolving credit” which is just a fancy term for any credit granted that can be paid down and then charged up again. Ultimately, this does mean credit cards because home equity lines of credit are counted as mortgages, not as revolving accounts.
And believe it or not, these accounts make up 30% of your credit score. That is almost a third of your score! Here’s how it works.
Your credit card usage as compared to the available credit is what is used to calculate this part of your score. The actual balances don’t matter at all, just the percentage you are using.
The smaller amount of the available credit on your cards that you are using, the higher your score can be. And the more of your available credit you are using, the lower you score can go.
In other words, two people can owe $1,000 on credit cards and one can have a bad score because of it while the other person can have a good score because of it.
A person who owes $1,000 on a credit card with a $1,200 limit is going to have a lower score and will have a very hard time getting any more credit, especially any additional credit cards.
Another person who owes $1,000 on a credit card with a $10,000 limit has put himself in a good position with regard to his credit card usage. This is going to help his credit score and make it easier to get additional credit if he wants it.
Ideally, you can keep your credit card usage below 30% of your available credit. So if you have $5,000 in available credit, the credit bureaus want you to use only $1,500 or less.
What this means is that if you need to use the full $5,000 and you want your score to be high, you will need more available credit, probably close to $20,000. I understand this isn’t always possible but it is also just a guideline. It doesn’t mean that if you go over 30% usage that your score is suddenly going to drop by 100 points.
After the 30% threshold, your score will start to go down gradually as your usage increases. The next threshold is at 50%. Once you go above that, it will hurt your score more.
The next point at which you will see more of a drop is at 75% and the final one is at 100%. If you go above the available credit, your score will really take a hit.
To fully understand all this, there are some more details you need to know. The first one is that this is a gradual scale. It isn’t as if your score stays the same from zero usage and then drops when you hit 30%.
Instead, your score will gradually drop as your usage increases. Each of these thresholds are markers the credit bureaus use to indicate an increased risk of you having late payments.
You see, their viewpoint is probably not the same as yours. Most people would think that if they have a $5,000 credit limit, they should be able to use the whole thing without any kind of penalty.
And why not? If you want a $250,000 mortgage or a $30,000 car loan, you apply for a $250,000 mortgage or a $30,000 car loan. You don’t apply for a $750,000 mortgage or a $100,000 car loan so that your credit score can be higher.
To make this a bit clearer, let’s go through an example of how you might set up your credit cards to maximize your credit score while being able to use the credit you need.
Taking the example of the $5,000 credit card, if you had that as your only credit card and needed to use $4,000 of it, you have some choices. If you need to use it right now regardless of anything else, you would just do it and suffer the consequences which would be a lower credit score until you paid it down.
Another option, if you have some time to work it out, would be to apply for more credit to increase the amount of available credit. It would be best if you could get approved for another $10,000 but that may or may not be available to you at the moment.
The alternative would be to get approved for as much as you could and use the lowest rate card or cards to pay for the item or service you need. Don’t worry if you can’t keep it under 30% or even 50%. Just do the best that you can and pay it down as soon as possible so you can get your usage down and your scores up.
With everyday spending, budgeting and business expenses, your credit scores can go up and down simply through credit card usage and paying down your balances.
This factor, if controlled, can be used to improve your credit scores and to plan ahead so that you can keep your scores where you want them.
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