This mistake could drop your credit score by as much as 50 points—here's how to avoid it
There are a number of best practices to follow when working on improving your credit score, from making sure to pay your balance on time to being cognizant of how often you apply for new cards. But one that can make an immediate impact on your credit score is keeping an eye on your credit utilization rate.
Credit utilization is the percentage of your line of credit that you are using. For example, if you have $10,000 in available credit and you put $5,000 worth of purchases on your credit card this month, that represents a credit utilization rate of 50%.
It is a major factor in determining your credit score, accounting for up to 30% of your score.
Experts traditionally recommend not using more than 30% of your available credit in a given month, and ideally keeping it closer to 10% or below. That's because to lenders, seeing a borrower put a lot of money on their credit card can be a red flag that they won't be able to pay back what they owe.
"If you have an account that is very high utilization, that is shown to be a high indicator of risk," Rod Griffin, senior director of consumer education at Experian, tells CNBC Make It. "For most people, if you're carrying a high balance, you're probably more financially stressed. The reason is simply because the higher your balances are, the greater risk you'll default."
Even if you have every intention of paying your bill in full, a high utilization rate could ding your score by as much as 50 points in the short term, Griffin says.
Griffin has experienced this firsthand. In 2019, he used one credit card to pay for a family vacation, loading it with fuel purchases, hotels, meals and gifts. Between November and December, his score dropped 40 points because of the higher-than-usual balance. Once he paid his balance the following month, his score climbed back up.
If you're sitting near the cusp of different credit score ranges — 750 to 799 is typically considered "very good" while 670 to 739 counts as "good" and 580 to 669 is "fair" — it's worth being cognizant of your credit utilization rate, especially if you plan on applying for credit in the near future.
By paying off a percentage of your bill before your monthly statement is generated, you can avoid a high utilization rate showing up on your report.
If you normally utilize 20% of your $5,000 in available credit but make a $1,000 purchase — for example on a new TV or computer — that bumps you up to 40%. But paying that off before your statement date can save your score from taking a hit.
But if you have a credit score near 800 or higher, don't stress too much about about a temporary 40 or 50 point ding.
"The only reason to get 850 is if you're making a bet with your wife," Griffin says. "If you're 750 or higher you're going to get the best terms and rates [from lenders]."
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