How you manage your credit cards has a big effect on your credit scores — one of the biggest effects, actually. In common credit score models, your amount of debt makes up 30% of your credit score, and a big part of that is a calculation called a credit utilization rate.
Credit scoring models generally determine that rate by dividing your overall revolving credit balances (the balances on your credit cards) by your overall revolving credit limits (the sum of the spending limits on your credit cards). So if your credit limits add up to $10,000 and your balances add up to $4,000, your credit utilization rate is 40%. In general, keeping your balances less than 30% of your available credit (or, even better, less than 10%), will help you build or maintain good credit. (It’s also smart to try and keep your credit utilization rate low on individual cards, but the overall rate generally has a greater impact on your credit scores.)
As one of our readers recently commented on our site, that’s a lot more difficult to manage than you think.
“Currently we charge all of our monthly expenses on my card, and don’t pay it off until the bill is due (so taking advantage of entire grace period). The issue I see with this is that in my credit report it is showing a constant balance on these cards, which will vary some every month and be somewhere between 15-30% of the card’s utilization. Is this good, bad or just OK? Would it be better for my credit to pay off the entire card just before the bill goes through? This way the credit report would show a constant $0 balance on the card. Or is that too bad?” — Danny
How Credit Card Balances Affect Your Credit Score
First, let’s address Danny’s question about good, bad or OK credit utilization. As we mentioned earlier, anything less than 30% is fine, but, generally, the lower your utilization rate is, the better.
Now, let’s talk about why his credit utilization shows up on his credit report as 15% to 30%, even though he and his wife pay their credit card balances in full each month.
The date on which your bill is due is not necessarily the date on which the creditor reports the account information to the credit bureaus. It’s hard to know when that happens. The simplest strategy for someone who wants to keep their credit utilization below a certain threshold — say, lower than 15% — is to never spend more than 15% of your available credit. That way, whenever someone requests your credit report, your credit utilization should be where you want it.
That’s a lot easier to do when you have a high credit limit. It’s basic math: The lower your credit limit, the faster your utilization will increase. You could just spend less to improve this aspect of your credit, but that’s not always an easy thing to do. You could also use a mix of credit and cash or debit to keep your credit utilization down while not changing how much you spend. If that tactic doesn’t appeal to you (perhaps you’re trying to maximize a cash-back benefit of a rewards card), there are a few other things you can try.
Smart Strategies for Managing Your Credit Cards
Requesting a credit limit increase could solve your problem. Keep in mind this could result in a hard inquiry on your credit report, which will ding your credit scores in the short term, but the increase in available credit, and its impact on your credit utilization rate, would likely outweigh that ding. If you don’t want to request a credit limit increase, or your creditor rejects your request, you could take a different approach.
Danny mentioned this strategy in his comment.
“I was thinking maybe I pay off everything except the 10% of the credit limit of the card every month before the bill comes, this way the credit report would show a constant 10% of the card limit every month as the debt and not zero?”
That could work, but, again, you probably don’t know exactly when your creditor reports your account information to the credit bureaus. This can make it difficult to time that extra payment. Some people take this strategy to the point of paying off credit card charges as soon as they’re posted to their account. You could also make a habit of checking your credit card activity frequently (a good idea, in general) and making payments any time your balance reaches or gets close to 15% of your credit limit (or whatever ideal rate you’re shooting for).
By doing that, you’re trading off the advantage of a grace period. One of the nice things about using a credit card and paying your balances in full by your monthly due date is your purchases don’t accrue interest. That can give you more flexibility in how and when you spend your money.
To summarize this tricky issue, there are basically three options if you want to improve your credit utilization rate: Spend less, increase your available credit while leaving your spending unchanged, or make credit card payments more often.
You can keep an eye on how your credit card spending and other financial habits are affecting your credit scores by getting two free credit scores, updated every 14 days, on Credit.com.
More on Credit Reports & Credit Scores:
- The Credit.com Credit Reports Learning Center
- What’s a Good Credit Score?
- How to Get Your Free Annual Credit Report