One of the biggest factors in your credit score calculation is what's called your amounts owed -- but the name is actually misleading. Credit scoring agencies, like FICO, don't look solely at the amount of debt you owe on its own; they look at what percentage of your available credit that debt represents.
The ratio of how much credit card debt you owe versus your available credit is called your credit utilization rate, and it contributes to as much as 30% of your credit score. Contrary to what you may think, though, the ideal credit utilization ratio isn't zero. Creditors want to see that you can use your credit limit responsibly -- not avoid using it entirely.
The popular wisdom is that a utilization rate above 30% is a red flag, but lower is even better. A rate between 5% and 15% can show you use your card regularly without making it look like you're taking on too much debt. So, if I'm shooting for a 10% utilization rate, how much available credit should I have?
The easiest way to figure out how much available credit you'll need for a 10% utilization rate is just find your average monthly credit card balance and divide it by 10% (0.10).
For example, the average American has a credit card balance of around $6,000. Dividing $6,000 by 10% gives us $60,000. This means if you had $6,000 in credit card debt and $60,000 in total available credit, your utilization would be 10%.
Of course, you have your own particular spending habits, so your exact numbers will likely be different. But the principle is the same no matter how much debt you carry. A quick way to get a good estimate of your balances is to go through the last 12 months of credit card statements and find the biggest credit card bill you received, then use that amount in your calculation.
If you find that you're using a lot more than 30% of your available credit regularly, you may need to consider increasing your overall available credit. You can do this in one of two ways:
As long as you don't start spending more, increasing your available credit will result in a utilization rate decrease. Depending on your credit history, however, either option could damage your credit score in other ways, so make sure to consider all the potential impacts before taking action.
A big reason you may worry about how much available credit you need is the potential credit score damage, so incurring a hard credit inquiry may be a dealbreaker. While your score should rebound after you pay down your balances, this can take time. Your credit card issuer will only report your balances once a month.
If you have an upcoming loan and need your score looking its absolute best, a few weeks could make a big difference. While you could simply spend less on your credit cards by using cash, you'll miss out on the convenience and rewards of using your cards. Luckily, the solution is simple: Make earlier payments.
Most of us spend money throughout the month -- but we pay our credit cards all at once. By the time the issuer reports your balance (often when your statement drops), they're reporting a full month's worth of spending. Instead, consider paying your credit card balance before you get the bill. You could even make multiple payments during the month to keep your balances low at all times.
The only instance where your credit limit can be too high is if you tend to abuse those limits. If that's the case: Stop using your credit cards, start tracking your spending, and make a budget. Regularly maxing out your credit cards will hurt your credit score and can lead to even deeper financial trouble.
As long as you're using credit responsibly, there's no such thing as having too much available credit. And since credit utilization accounts for a large percentage of your credit score, it's in your best interest to maximize your available credit, as long as you don't let it change your spending habits.
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