How Does Credit Utilization Work?

Question: I had 72% usage on my credit accounts. All I’ve done this month is pay them down, however, today my report updated to reflect 74% usage. How is this possible? And more importantly, what the heck else can I do to make my usage go down? – Jay in California

Ashley Davison of Credit Saint\ responds…

This may come as a shock but: Paying your credit card when it’s due may be lowering your credit score.

One of the first things you learn about credit is the importance of revolving credit – credit cards. Love them or hate them, credit card balances account for 30% of your credit score and can make or break you depending on how you manage them.

When I work with clients, it’s not uncommon to see them with at least one maxed-out credit card. They rarely realize how dramatic the impact can be – I’ve seen as many as 100 points deducted overnight for maxed-out cards (that was my score, by the way, so I know exactly how that feels). Anything North of 50%-60% of your total limit can do this, and the closer you get to your combined credit limit the worse it gets (not to mention the ever-climbing interest rates that are being calculated at your statement closing date).

The good news

This kind of damage lasts only as long as the high balances do. Pay your balances down to 50% or better and your score snaps back once the card company and the bureaus talk to each other. They do that once a month on average, so it shouldn’t take more than 30 days to see that change. For example, the first picture below shows what is most recently reported on my credit report. The picture after is my actual statement showing a lower balance. The information will catch up but might take up to 30 days.

Every now and then, I speak with someone whose cards are showing as maxed out on their credit report, their scores are in the gutter, but in reality, they pay all of their cards to $0 every single month.

And this is where it can get tricky.

These poor folks are all being punished for doing the same thing: paying their bills on time! Your credit card company reports only once a month and surprisingly it is sometimes nowhere near your billing date. That means having to juggle reporting dates to make sure your cards aren’t running high balances when they report, or your scores could take a nosedive.

The solution

You can learn your reporting dates from your card companies, or your credit reports, but each report may have a different date for the same card. The best method for managing your balances depends on your goals.

If you have generous balances and low usage, you may not have to worry so much because there’s a nice big buffer between you and the danger zone (just above 55% of your maximum balance) where your score starts to suffer. If you make an unusually large purchase, think about making an extra payment right afterward to keep reported balances low.

If you often see yourself coming close to your limits, try splitting your regular monthly payment in half and paying twice as often. If you have lots of regular expenditures around the same time every month, you can make a larger payment then and a smaller one, two weeks later.

Conclusion

If you are just starting out and building credit, your limits are probably low. Consider only using your card once a month to pay a bill, set your checking account to pay the card right after the bill gets paid, and then leave the card alone. These cards are just for racking up on-time payments, not shopping, so it’s useful to think of it as a credit-building tool and not a way to spend money.

This issue frustrates a lot of people, but you don’t have to be one of them. Be prepared, and make your credit card work for you!