Debunking a credit score myth: Forget what you’ve heard. Use much less than 30% of your available credit card limit

October 3, 2019

People like benchmarks, because it helps when they’re trying to reach a goal.

For instance, when I talk about saving for retirement, folks want to know how much should they save every year or what percentage of their income should be invested.

For the answer to that question read: Want to be a 401(k) millionaire? Here’s what it takes.

One of the most frequently asked questions I get is this: How can I improve my credit score?

That three-digit number is part of the gateway to a good loan, an apartment and even a better auto insurance rate. FICO, the score used most by lenders, ranges from a low of 300 to a high of 850.

In FICO’s credit-scoring model, the top two factors that determine your score are your payment history and the amount you owe. Let’s explore the latter.

Thirty percent of your credit score is made up of how you manage debt or your “credit utilization.” This just means what percentage of your available credit is being used or borrowed.

FICO, the company that produces the score by the same name, says its formula views consumers who are constantly maxing out their credit cards or exceeding their credit limit as a potential risk.

Okay, so you might ask: How much of my available balance should I be using?

I’ve been told by numerous experts that consumers should have a credit utilization rate of no more than 30 percent. So, for example, if your credit card limit was $1,000, you should keep your balance to $300. This suggested guideline would apply for each individual credit card and the overall utilization for all your cards.

But the truth is that 30 percent ceiling isn’t a hard-and-fast rule baked into the scoring programs.

“There is nothing significant about 30 percent revolving utilization. It’s relative,” said Ethan Dornhelm, vice president of scores and predictive analytics at FICO.

In fact, if you’re striving for a perfect 850 credit score, you should aim for single-digit credit utilization.

Dornhelm said recent company research has shown that the highest-scoring 25 percent of U.S. consumers — those with a FICO score above 795 — use, on average, 7 percent of their credit limit. The average revolving utilization for consumers with a perfect 850 credit score was 4.1 percent.

“Using a high percentage of your available credit means you’re close to maxing out your credit cards, which can have a negative impact on your FICO score,” Dornhelm said. “On the other hand, using a low percentage of your available credit can have a positive impact. In some cases, a low credit card utilization ratio will have a more positive impact on your FICO Scores than not using any of your available credit at all.”

This question about credit utilization often leads to one of the biggest myths about paying off your credit card. Here’s a recent question from a reader.

Q: Why does everybody constantly say to pay off the credit card every month? If I did this, it would never hit my credit report, and it would be like I’m not using it at all. Am I missing something here?

Dornhelm: “One of the biggest misconceptions about FICO score is that you have to carry a balance on your credit cards and not pay off your credit card balances in full to build a credit history. This is not true. Carrying balances from month to month and incurring interest fees does NOT help your score. Instead, what matters to the FICO score is that you are keeping the balances reported in your credit file (typically your credit card statement balance), relatively low, especially in comparison to your credit limits.”

Here’s more myth-busting on the paying off of balances from two additional credit experts:

Jeff Richardson, vice president and group head for marketing and communications for VantageScore Solutions. VantageScore is the scoring model created by the three major credit bureaus: Equifax, Experian and TransUnion.

Amy Thomann, head of consumer credit education at TransUnion.

Thomann: “Paying off your credit card balance each month is a good idea, because it will prevent your account from being delinquent plus prevent any finance charges or late fees. Always keep in mind the foundational principles of credit health. It’s imperative to pay any bills on time and in full each month and maintain a low credit utilization ratio.”

Richardson: “If you pay your credit card balances completely each month, it will reflect positively in your credit score. The credit score rewards an open and active account in good standing with a zero balance. Despite paying off the balance, a lender continues to report usage because there is activity occurring even though the balance is zero. By contrast, if you have a credit card with no activity (such as a backup credit card that you keep in a drawer for emergencies), the lender may stop reporting on the account due to inactivity. The inactive account will have less positive impact on credit score compared to an active account in good standing with no/low utilization. One suggestion would be to use a credit card such as this to autopay for a small subscription such as one’s streaming video account, which will keep the account and credit line open.”

The moral of this credit score lesson: Have good credit, but don’t use much of it.