Among the other statistics collected on your use of credit by the agencies who gather this information, is “credit utilization.” If you have a $10,000 credit limit across all your credit cards and you have a balance of $4000 across the cards, then your debt is forty percent of your credit limit. That means that you are using forty percent of the amount of credit available to you. The higher percentage of debt to credit, the lower your score is.
Basically, credit utilization is a measure of how well you are handling the credit you have. If you are maxing out credit cards right and left, your credit score is going to be low because it looks to lenders as if you are not able to handle your debt. They wonder if you are headed towards not being able to pay your bills since the amount of credit you are using is close to the amount of credit available to you.
If, on the other hand, you have $10,000-worth of credit limit and you use only $1000 (ten percent credit utilization) your score is going to be higher because it looks to the lenders as if you know how to handle credit.
Reducing your credit utilization is one of many things in money management that gets easier over time, simply due to the reactions of lending institutions to efforts in this direction. If you lower your debt load significantly and keep it low, companies are going to want to give you more credit cards with higher credit limits. Open up a couple more accounts, keep your debt load low (pay off your balance every month is the best way to do this), and pretty soon you will have a high credit limit which means you have a little bit more of their money to use each month without incurring credit score penalties.
Remember that to the lender, credit limits are a balance between setting up a strong potential profit for themselves through your interest payments and ensuring that you are able to actually pay your bills. Understandably, they are likely to err in their estimation on the side of profit, so it is advisable to stay well below your credit limit.
Credit cards are a wonderful convenience because they keep you from having to carry cash and they can help you keep track of where your money is going. In order to keep them from becoming a burden, pay your balance every month and avoid spending more than you can pay for. That way you can enjoy the advantages of a credit card without the disadvantages.