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What is credit utilization, and how does it affect your credit score? FICO scores can be intimidating (especially if you don’t quite understand them). We all know that maintaining a high FICO score is helpful in many ways, from being able to obtain great interest rates on home loans to saving money on your car insurance and avoiding those expensive deposits with the cell phone company or cable providers.
I’m dropping the video here if you’d prefer to watch or listen instead of reading. I summed up what is credit utilization in less than 5 minutes, but I wanted to gather my thoughts in note form because I know you’ll want to bookmark this page. 🙂 Don’t forget to subscribe to my YouTube channel for more practical money tips for the free-spirited nerd!
To understand the importance of credit utilization and how it affects your credit score, we first have to look at FICO’s five factors they consider when scoring individuals.
Five FICO Factors
- Your Payment History >> Do you make your payments on time every month?
- Credit Utilization Ratio
- Length of Account History >> How long have your accounts been open?
- Length of Accounts >> How Many Accounts are New?
- Type of Account Mix >> Are you well-diversified, with a variety of different loan accounts, such as mortgages, secured loans (such as your car loans), and unsecured debt?
These five factors are all considered when Experian, Equifax, and Transunion calculate your credit score. But here’s something you probably didn’t know.
Out of all five factors that FICO considers when calculating your FICO score, credit utilization makes up nearly a third!
What is Credit Utilization
So what is credit utilization exactly? It’s the balance of credit in proportion to limits set by creditors. Simply put, it’s the percentage of credit used vs total credit limit.
But here’s where things get kinda confusing. FICO assigns a different weight to different types of debt. Revolving lines of credit, or credit cards, tend to carry more weight than home mortgages and secured loans, such as your car note. FICO doesn’t keep track of your vehicle values, so if you’re upside down on your car loan, that won’t affect your credit utilization, but it’s still a good idea to get out of that situation quick if you owe more than your car is worth. I wrote about how to sell an upside-down car here. Or if you’d prefer to watch a quick video, you can do that, too.
A very important thing to consider regarding credit utilization is that the higher the balances on your credit cards and revolving lines of credit (even overdraft protection lines of credit through your bank), the more damage it will do to your credit score. If you’re looking for ways to build your credit score without the use of credit cards, check out my absolute favorite banking product to do just that.
So now that you understand a little bit more about what is credit utilization and how it affects your credit score, what are you gonna do about it? Drop a comment below and give me your thoughts. Don’t forget to subscribe so you don’t miss out on a single post! This is just part one of a three-part series of banking terms and definitions.
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