According to Experian, one of the three credit reporting agencies, “your utilization rate is the second most important factor in credit scores.” Most people do not realize this, as it is often not discussed or explained. Putting this in simple terms, the utilization rate is the amount of credit used (current charges & previous balance) divided by the credit limit. If you payoff as much of the balance as possible before the credit card statement closing date, a lower balance is reported to the credit agencies (Experian, Transunion and Equifax) and the utilization rate is lower. Please note, the closing date is different from the payment due date and can typically be found on the first page of the monthly statement or within the online statement. In general, if your monthly balance is 30% of the limit or less, it looks better to the credit agencies and will thereby increase your credit score over time. To send the payment earlier may be difficult at first, as requires good cash management and takes a little more time to review and send the payment, but when it becomes a habit the rewards are great. Other benefits:
- It may allow you to qualify for a higher home loan payment because your debt-to-income (DTI) ratio is lower.
- If you raise your credit score by 20-40 points, it may mean $1,000’s in savings on your next home, car, boat or RV loan.
- It may be the difference of being approved or denied on your next loan. In today’s lending environment, the average minimum credit score required to become approved is higher than it has ever been.
For example, on one of my credit cards I purchased $924 worth of clothes and food from 9/1/12 to 9/25/12. My credit limit is $1,500 and closing date is the 2nd of every month. On 9/27, five days before the credit cards closing date, I accessed my account online and electronically paid $700, which is to be received and applied by the credit card company closing date of 10/2. So, my balance was $224 and utilization rate 224/1500 = 14.9% when it was reported to the three credit agencies and much lower than what I actually charged for the month.
If you take control of the factors that impact your credit score, you will better control your score and the fees that lenders can charge.
Industry quotes. According to:
Transunion: “Outstanding debt: High balances in relation to your credit limits can lower your credit score. Aim for balances under 35%.”
Experian: “Your utilization rate is the second most important factor in credit scores. Also called your balance-to-limit ratio, your utilization rate is the ratio of your total balances compared to your total credit limits.” “Work on reducing your debt so that you’re utilization rate is under 30% on all your revolving credit accounts.”
Equifax: “The amount you owe accounts for 30 percent of your score, and so you want more available credit than debt.”
Per Bankrate.com, “scores of 620 or lower usually place a borrower in the “subprime” category, and they can expect to be quoted significantly higher interest rates and may be offered fewer varieties of loans.”
Per the LATimes article, “How about the profiles of people who applied for conventional loans to buy a house but were rejected or didn’t get to closing? By historical standards, they were a fairly impressive group on average as well, with 732 FICO scores, 19% down payments and debt-to-income ratios of 24% (housing costs) and 41% (total debt). ”