When trying to improve your credit score, one of the most common tips you’ll hear is to keep your credit usage rate low enough.
But what really happens if you do not follow this advice? I discovered this recently because my credit utilization rate temporarily exceeded 50%. As soon as this happened, my previously excellent credit rating plummeted because I was using up so much of my available credit.
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The impact of high credit utilization
First of all: it’s important to understand what your credit utilization rate is.
Your credit utilization rate is calculated by dividing the credit you used by the credit you have available. If you charged $ 2,000 on a card with a limit of $ 4,000, you can calculate the ratio by dividing $ 2,000 by $ 4,000. In this case, your 50% utilization rate would be higher than the recommended rate, as you will have to keep that rate below 30% to get the best score.
While I always pay off my credit cards in full each month, my credit utilization rate is sometimes over 0% because credit card companies report the balance owing at a specific time of the month. If my card issuer reports my usage rate on the 15th, for example, and I pay my card off on the 20th, my credit report will show that I owe the card. Still, because I have a lot of credit available, my usage rate has always been below the recommended 30%, until recently.
In November, I billed very expensive airline tickets and vet bills for my dog, which meant my utilization rate was temporarily over 50%. I did this to earn reward points on my purchases. But the result was that my score, which was 779, dropped to 747.
This drop came despite nothing else having changed and despite having several other cards with tons of credit available and balances of $ 0. On top of a 50% utilization rate on this a card alone was enough to lower my score by over 30 points.
Does a 30 point drop in your credit score matter?
A 30 point drop in a credit score might not seem like much, but sometimes it can be enough to send you into a different level of risk, depending on where your credit score started. If you had a score of 740, for example, your credit would be classified as “very good”. But, if that score fell to 708, you would only be in the “right” range.
Falling to a riskier level means that interest rates may be a little higher than they otherwise would have been. If I had applied for a mortgage or car loan after my score dropped, my card almost to the max might have cost me thousands of dollars in the long run.
Depending on where your score was when you started, a 30-point drop could potentially be the difference between approving a loan or denying it.
How to avoid a big drop in your credit score
The only way to avoid hurting your credit score by using too much of your available credit is do not to use more than 30% of your line of credit on any credit card. Ideally, getting this utilization rate as low as possible is ideal.
If you make a large purchase like I did, you can actually pay the amount you charged before you get your statement – and before the credit card company has a chance to report your high usage rate to credit bureaus. If I load that much on my card again, I will take this approach.
Even if you do not pay off the card immediately, it is imperative to pay it off as soon as possible because when your usage rate drops, your score increases again. I have since paid off my card and my credit score in December is back to where it was before.
Use of credit account
It is clear from my sharp drop in credit score that credit reporting agencies really do worry about the use of credit, even if you are an otherwise responsible borrower. Since a high usage rate has such a huge impact, it’s important to avoid getting too close to the maximum of your cards, especially if you are taking out a large loan in the near future.