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Here’s What Everybody Gets Wrong About Credit Utilization

If you’ve ever read about how credit scores work, you’ve probably heard about credit utilization. This is the ratio between your credit card balances and their credit limits. For example, if you have one credit card with a $5,000 balance and a $10,000 limit, your credit utilization is 50%.

Credit utilization is one of the most important factors in your credit score. And the golden rule everybody repeats is to keep your credit utilization below 30%.

It’s not a bad rule. I’ve repeated it myself quite a few times. But it’s also a simplification of credit utilization, and it’s not entirely accurate. With a better understanding of how credit utilization works, you’ll have a much easier time managing your credit score.

30% isn’t the magic number — lower is better

The 30% rule for credit utilization gets thrown around all the time. It gives the impression that using under 30% of your credit is good, and 30% or above is bad. That’s the biggest misconception about credit utilization.

It’s more accurate to say that the lower your credit utilization is, the better. Utilization of 10% is better than 20%, which is better than 30%. Consumers with a FICO® Score of 800 or above, the highest range, have 7% credit utilization on average.

What makes it confusing is that 0% credit utilization is actually considered worse than 1% credit utilization. That’s according to Experian, one of the three credit bureaus that calculate credit scores. It’s a quirk of credit scoring systems. But this isn’t something anyone needs to worry about — you can have an excellent credit score with 0% or 1% utilization.

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So, where’d that 30% rule come from? Experian has clarified that “while there’s no specific point when your utilization rate goes from good to bad, 30% is the point at which it starts to have a more pronounced negative effect on your credit score.”

Only your current credit utilization matters

Some people learn about credit utilization, and they think they need to micromanage it. This is understandable, especially if you use a free credit score tool that sends out alarming updates like “Alert: Your credit utilization went up.”

The only number that matters is your current credit utilization. That’s what lenders see when they check your credit, and that’s the number used to calculate your credit score. If your credit utilization is 5% right now, it doesn’t matter if it was 75% two months ago. Your high credit utilization two months ago affected your credit score then, but not anymore.

If you have any sort of credit check coming up, then you should make sure your credit utilization is as low as possible. For example, your credit utilization is important if you plan to apply for any of the following in the next month or two:

When no one’s going to check your credit score in the near future, your credit utilization isn’t a big deal. You should, however, aim to pay off your credit cards in full every month. By paying in full, you won’t be charged interest on your purchases, and you’ll avoid debt.

Credit utilization history could be important with new scoring systems

There are many credit scoring systems out there. FICO® Score is the most widely used by lenders, but even that has dozens of variations. There’s FICO® Score 8, FICO® Score 9, and FICO® Score 10, plus other versions used in auto lending, credit cards, and mortgage lending.

The scoring systems that are currently used don’t consider your credit utilization over time. As explained above, only your current credit utilization matters. But new credit scoring systems, including FICO® Score 10, look at data trends over 24 to 30 months.

If companies start using these newer scoring systems, then your historical credit utilization could become important. For now, that’s not the case.

How to handle your credit utilization

To sum it up, it’s always a good idea to pay your credit cards in full to stay out of debt. If you do that, your credit utilization will be low, which helps your credit score.

If your credit utilization increases from time to time, that’s not necessarily an issue. You don’t need to always keep it below 30%. That’s just a rule of thumb. The only time your credit utilization comes into play is when someone’s checking your credit score, and it’s just your current credit utilization that matters.

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