An Easy Way to Boost Your Credit Score
I was talking with one of my dearest friends the other day when the usually thorny subject of personal finances came up. Turns out, like many other folks, she’s struggling to make ends meet and we ended up having a real heart to heart. Now, I’m no financial expert but I do like to find out things, especially when I think it can help people I care about. I thought this information might prove useful to some of you out there.
When people think of financial stress, they often think of being in debt. After all, when it comes to financial stress, what could be worse than living with the thought of owing other people money?
But debt isn’t the only thing that can cause financial stress, having a low credit score can also cause you to have a lot of stress. Even if you don’t have creditors breathing down your back all of the time, having a low credit score can ruin your chances of getting a new home, destroy your ability to get a loan, and affect your ability to get a credit card. And make no mistake, these things can start happening even if you aren’t getting calls from creditors all of the time.
There is a lot that goes into determining your credit score, also called your FICO score. Your FICO score is determined by a formula that is based on your credit report. The actual formula is something that FICO keeps close to its vest. It doesn’t matter if you feel like you pay your bills on time or if you know that you avoid your financial responsibilities, if the FICO formula determines that your credit score is low, it can wreak havoc on all of the financial areas of your life.
Even though we don’t know a lot about the FICO formula itself, one thing that we do know is that your utilization rate plays a big role in the overall FICO score.
What is your utilization rate? To put it simply, it gives an idea of how much you are using your available credit. In other words, let’s say that a person has a credit line of $25,000 and they are using $24,900 of that credit line. They might pose a bigger credit risk then someone who takes out a $25000 credit line and only used $1000 of that credit line.
Of course, this doesn’t always mean that you are a bigger credit risk, especially if you have other lines of credit that you are able to pay off quickly. But in some cases, people take multiple lines of credit and they have them all maxed out, this makes them a bigger credit risk then someone who doesn’t use their credit line as much.
There are a lot of mysteries about the way FICO uses the utilization rate, it is never an exact science. But in one area, you can use the utilization rate to increase your credit score fast.
The Crazy Thing About Credit Utilization
FICO does not measure your average utilization rate, instead it bases your score on your highest utilization rate.
So let’s say that you own two separate credit cards, and each of these cards has a $5000 limit. Now let’s say that one of those credit cards was maxed out while you hadn’t even touched the other credit card.
What happens here? The maximum utilization rate would equal 100%. So in this example, there will be a negative impact on your credit score.
Now let’s say that you had the same two credit cards with the same credit limit of $5000, but instead of maxing out one of those cards, you used $2500 of the $5000 credit line on each one of the cards. In this case, the maximum utilization rate would only be 50%.
Do you see what a difference there is in the two examples? In both examples, the total credit used is the same, ($5000), but the way that it is used is completely different. In one instance, all of the credit is taken from one place, in the other case, you are balancing your credit between two cards.
More Important Things to Know About Utilization Rates
Ideally, you should aim to have a utilization rate of 35% or less on each of your credit cards. Even if you have just one card that has a utilization rate over 35%, your max utilization will increase and your overall credit score will be affected.
Your utilization rate is important! In fact, there was a study done of 70,000 different credit scores and in that study researchers discovered that those people who had a credit score of 720 and above also tended to have a utilization rate of 20% or under.
At the same time, those people who had a 0% utilization rate usually had a poor credit score. In fact, their credit score is usually so low that they can’t even qualify for a credit card. In other words, one thing you don’t want is a 0% utilization rate.
Use these simple tips to try to lower your utilization rate. Remember, your goal should be to get your rate under 35%.