Do High Credit Card Balances Hurt Your Credit Score?

I’m trying to improve my credit score before I buy a home. I’ve heard high balances can be bad for your credit. So, what’s the right amount of credit card debt to have for a good credit score?

Lacey

St. Olaf, MN

Hi, Lacey,

This is a great question and it’s good to hear that you’re taking the necessary steps to raise your credit score before you buy a home. There is no “right balance” to maintain, but there are methods to help improve your credit score that we will gladly go over. If you have any questions, please give us a call at 1-888-294-3130 to speak with a certified credit counselor so they can assist you directly.

How to Maintain a Healthy Credit Balance

There are several benefits to having a good credit score. You get to enjoy perks like lower interest rates on credit cards and loans, while also getting to save on insurance and avoiding security deposits on new utilities or cellphone plans. And one of the first steps to maintaining a good credit score is by understanding how credit utilization works.

What is a credit utilization ratio?

A credit utilization ratio is the amount of revolving debt you are using divided by your total revolving credit available. Think of this as what you currently owe divided by your total credit limit. This is usually represented in a percentage.

In layman’s terms, credit utilization is the ratio between your credit card balance and your available credit limit for all credit cards. Therefore, the higher your credit balance is relative to your credit limit the lower your credit score.

How does credit utilization work? (utilization per card and overall)

As you’ve probably deduced by now: Debt plays a major role in one’s financial life. Not only can it affect your spending ability, but debt can severely impact your credit score as well as your ability to borrow money and/or pay a low insurance rate.

So, how does credit utilization work exactly? Let’s breakdown some numbers:

If you have $5,000 total credit available over three cards and a balance of $2,500 then you are using half of your credit, which when calculated ([2500 ÷ 5000] x100 = 50%) leaves you with a 50 percent credit utilization rate. Additionally, if you feel so inclined, you can calculate your credit utilization ratio for each credit account, known as individual utilization ratio or per-card ratio.

To calculate, simply readjust your calculations to represent the balance on an individual card and then use that card’s credit limit. For example: $2,000 is your credit limit on one card and the balance on the card is $500. So, your calculations should look like this: ([500 ÷ 2000] x 100 = 25%).

How important utilization is for your score

Utilization, which is the second most important factor that affects your credit score, accounts for 30 percent of your score. First place goes to payment history, which accounts for 35 percent of your credit score. However, when lenders are deciding whether or not you are a good candidate for credit, they will use your credit balance as an indicator. Do you depend heavily on your credit? If so, a lender will consider you to be a high-risk candidate.

For example: If you were given a jar containing 20 cookies and you chose to eat all of them at once, people would be unlikely to trust you with more cookies. But if you were to only eat five of the cookies when there are 20, you appear more reliable. In other words, lenders want to make sure you are capable of restraint and you have a solid sense of financial responsibility.

Which types of debt affect credit utilization?

Several types of debt can affect credit utilization:

  • Revolving Credit: This is a form of credit that carries a balance month to month once you are assigned a credit limit that you can charge and make payments on monthly. E.g. Credit cards.
  • Charge Cards: These are similar to credit cards except that the card’s balance is to be paid at the end of each billing cycle. So, there is no revolving month-to-month balance, but you usually do pay an annual fee.

Note, however, how not all credit accounts have the same impact on credit score. Revolving accounts are weighed more heavily because they are a better indicator of credit risk compared to installment accounts. Although less important than utilization on revolving accounts, the amount of debt owed on installment loans still affects your credit score. However, the balances on your loans do not affect your credit utilization ratio.

Total utilization versus per card utilization

In most credit scoring models, both your overall utilization ratio and your per-card utilization ratios matter.

  • Overall utilization ratio: The total amount owed on your combined accounts
  • Per-card utilization: The amount owed on each account

Creditors may also look at the ratio of accounts that you have with no balance compared to the accounts you have that carry a balance.

Tips for keeping your utilization ratio low

  • Pay more than the minimum – Not only will paying more than the minimum payment each month keep your credit utilization low, it can also help you pay less interest.
  • Make multiple payments a month– Every little bit helps, so if making a single large lump sum payment a month doesn’t work for you, try making more payments with a few more dollars attached than you normally would make with a larger single monthly payment.
  • Leave credit cards open – Even after you pay off a credit card balance, make sure to keep the account open. All that unused credit will help lower your overall credit utilization, which will only aid your attempts to raise your credit score.
  • Make use of balance alerts– Push alerts are a great method of helping curb spending and helping keep balances in check.
  • Request an increase of your credit limit– If you are in good credit standing, ask your creditor if they will increase your available credit limit. However, resist the temptation to pile on more credit debt so you can lower your utilization rate.