Credit Education

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03. Aug, 2016

Credit Card Utilization Rates And Your Credit Score

Good credit scores increase borrowing possibilities and reduce the cost of borrowing. Lenders always assess the risk each borrower represents. They try to avoid lending to anyone likely to default or not pay on time. A high credit score indicates someone regularly meets their financial obligations. Lenders also assess income and other factors that raise repayment risks, but the credit score could be the deciding factor. It serves as the borrower’s advocate before the bank manager. It helps get the credit application approved and influences the loan terms.

How Bureaus Calculate Credit Scores
The advantages of good credit scores are well publicized. Most people have heard about how a good credit score helps personal finances. However, knowledge of how credit bureaus calculate credit scores isn’t so widespread. Many comments online mention how hard it is to understand why bureaus give such low credit scores. Now and again, rumors circulate that discrimination against certain groups affects credit scores. A better understanding of credit score calculation reveals these stories are without basis.

Credit bureaus calculate credit scores according to the customer’s credit history. They receive credit history data from lending institutions and government agencies. These figures show the customer’s debt and how well it’s managed. Some credit history elements have more influence on credit scores than others. For example, a history of timely payments without defaults makes a bigger impact than credit history length.

The Credit Card Utilization Rate Factor
One of the most important influences on credit scores comes from the customer’s credit card utilization rate. This awkward term actually describes an easily understood concept. This rate shows the amount of available credit in use. For example, if someone uses $6,000 of their $18,000 available credit, they have a 30% credit utilization rate. The faster available credit gets used, the higher the chance they’ll end up unable to cope with their debt.

Lenders become uneasy in the presence of borrowers with high credit card utilization rates. They class them as ‘bad risks’. If a credit report shows a customer uses a high percentage of available credit over a long period, the bureau lowers their credit score. Many experts suggest keeping credit utilization rates below 30% to avoid a negative impact on credit scores. Others claim this rate should be kept below 20%.         

How to Control Credit Card Utilization
Regularly check credit card spending. Order credit reports from the bureaus throughout the year. In addition, arrange for the credit card company to send an email or text alert once a certain percentage of available credit is exhausted. If 20% or 30% of that credit line is used on one credit card, switch to another credit card.

If it proves too hard to limit spending on certain credit cards, consider raising the card limits. If spending remains at the same level, an increase in the credit card limit automatically improves the credit utilization rate. This approach has its own risks. If an increase in credit limit leads to more spending, all gains will be lost.

Another option worth considering is making credit card balance payments more often. Suppose spending is fairly even across the month, but it still takes up 50% of available credit on the card. If this credit card user pays once a month, their credit card utilization rate equals 50%. However, if they pay twice a month, they could halve this rate.

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