What to Know About Credit Utilization

One of the key factors that determine your credit score is your credit utilization ratio. In fact, this ratio accounts for as much as 30% of your credit score. With this much influence on your credit score, it’s important to understand what credit utilization is, how to calculate it, and how it impacts your finances.

This article delves deeper into the answers to these questions. It also provides valuable tips for improving your credit utilization ratio.

In This Piece

What Is Credit Utilization?

In the most basic terms, your credit utilization is the amount of debt you owe in comparison to your overall credit limit. Only revolving credit is used when determining credit utilization. Things like mortgage loans, car loans, and student loans aren’t included.

What Is Revolving Credit?

Revolving credit is any type of credit account that continuously renews as you pay off the debt connected to that account. Some prime examples of revolving credit include credit card accounts and home equity lines of credit.

How to Calculate Credit Utilization

You can easily calculate your credit utilization ratio using a credit utilization calculator or the following formula.

  • Start by adding up all your revolving credit account balances.
  • Next, you need to add together the credit limit amounts for each of these accounts.
  • With this information, you can calculate your credit utilization ratio by dividing your total account balances by the total credit limits and multiplying this total by 100.

Credit utilization ratio formula: (Total amount of revolving credit account balances / Total credit account limits)  x 100

How Balance Reporting Affects Credit Utilization

While credit card companies are under no obligation to report your credit information to the credit report agencies, almost all of them do. In fact, most credit cards submit your credit information every billing cycle. This means your credit card company will likely update your credit card balance every 25–30 days or so.

This frequent reporting affects your credit score because the amount of credit you have available versus your credit balances impacts your credit utilization ratio. Depending on your spending and repayment habits, credit card balance reporting could cause your credit score to change from month to month.

Understanding Per-Card vs. Overall Utilization

It’s important to understand the difference between overall credit and per-card utilization. Your overall credit card utilization combines all your revolving credit accounts into one ratio. Your per-card utilization only takes into account one card at a time. For per-card utilization, you can use a credit card utilization calculator or the formula listed above, but instead of adding all your account balances together, you calculate each card separately.

Most experts recommend keeping your overall credit utilization score under 30%. However, some creditors look at revolving accounts separately. It’s a good idea to spread your revolving credit across multiple accounts rather than just one or two credit accounts. This keeps the credit utilization from getting too high on any one card.

There are also two other utilization numbers that could be helpful to know:

  • Line-item utilization measures your individual credit card balances against your individual limits. For example, suppose you have three credit cards, each with a $10,000 limit. Based on your current balances, your line-item utilizations break down like this:
  • Card A: Balance of $4,500 / Credit limit of $10,000 = 0.45 × 100 = 45% utilization
  • Card B: Balance of $2,000 / Credit limit of $10,000 = 0.20 × 100 = 20% utilization
  • Card C: Balance of $3,300 / Credit limit of $10,000 = 0.33 × 100 = 33% utilization
  • Aggregate utilization is the average of your credit card utilizations. Calculate yours by combining your current balances and dividing them by your total credit limit. In the example above, your total balance is $9,800 and your total limit is $30,000; therefore, your aggregate credit utilization is $9,800 / $30,000 = 0.32 × 100 = 32.6%

Why Is Credit Utilization So Important?

Every factor of credit scoring is crucial, but credit utilization is responsible for 30% of your overall score, second only to your payment history’s weight of 35%. Credit utilization measures your revolving balances against your total credit limit.

Lenders and credit card issuers rely on credit utilization to predict risk and future behavior. In general, the higher your utilization ratio, the greater your risk of defaulting on your balances. Risky behavior isn’t rewarded in the world of credit scoring, and you may see a decrease in your scores as your utilization ratio goes up.

How Does Credit Utilization Affect Your Credit?

Your credit utilization ratio directly impacts your credit score. In fact, five primary factors influence your score for FICO and VantageScore, the two most common credit scoring companies used.

The Five Credit Factors

  1. Payment history: Your payment history, including both on-time and late payments.
    FICO: 35% of your credit score
    VantageScore: 41% of your credit score
  2. Credit utilization: The amount of debt you have compared the amount of your current available credit balance accounts.
    FICO: 30% of your credit score
    VantageScore: 34% of your credit score. This includes credit utilization, outstanding balances, and available credit.
  3. Age of credit history: The length of time you’ve held each credit account.
    FICO: 15% of your credit score
    VantageScore: N/A
  4. Account mix: The different types of accounts you have. You should have a variety of accounts, including installment loans and revolving credit accounts.
    FICO: 10% of your credit score
    VantageScore: 20% of your credit score
  5. New credit inquiries that impact your credit score. Work at building your credit slowly to reduce the risk of too many hard inquiries to your account over a short period of time.
    FICO: 10% of your credit score
    VantageScore: 11% of your credit score

What Is a Good Credit Utilization Ratio?

Experts agree that you should try to keep your credit utilization ratio under 30% if possible. When it comes to revolving credit, you may also want to keep your credit utilization ratio under 30% for each account you have.

How to Improve Your Credit Utilization

If your credit utilization is higher than the recommended ratio of 30%, you can take several steps to improve your rate.

1. Check Your Credit Reports for Accuracy

It can’t be stressed enough how important it is to check your credit reports for accuracy. You’re entitled to one free credit report from each of the major credit reporting agencies every year. If you haven’t requested your credit reports within the last 12 months, do so today.

Once you receive your credit reports, make sure your personal and financial information is correct and up to date. If you notice any errors, take the necessary steps to file a dispute with each credit bureau reporting the error.

2. Pay Down Your Balances

Another step you can take to lower your credit utilization ratio is to pay off some of your debt. There are several methods you can use to pay off your debt, including a debt consolidation loan, the avalanche method, and the snowball method. The more debt you can pay off, the bigger impact it will have on your credit utilization ratio.

3. Request a Credit Increase

Requesting a credit limit increase on one or more of your revolving credit accounts can also help to improve your credit utilization. Keep in mind that this strategy only works if you also limit spending on these accounts. If you use these increased credit limits to make more purchases, it could actually increase your credit utilization ratio.

4. Consider Balance Transfer Cards

Another option for lowering your credit utilization ratio is to open a balance transfer card. Many of these cards offer a 0% introductory interest rate. Transferring your balances to this new card won’t decrease your credit utilization. But it can help reduce your interest costs and keep your utilization rates from increasing each month. This can also help you pay down your debt more quickly.

5. Change Your Bills’ Due Dates

If you’re having trouble making your credit card payments on time, you can request to have your due date changed. For example, if you get paid on the 1st and 15th of each month, you may want to move your due date closer to the 20th.

This step ensures you’ll have enough money to make these payments. Making your due date closer to your payday can also encourage you to pay off more of your balance before you have time to spend your money on other things.

Does Opening Credit Cards Improve Your Credit Utilization?

Opening a new credit account can help to improve your credit utilization ratio by increasing the amount of credit you have available. However, if you use this card to make more purchases and can’t pay the balance off each month, it can actually hurt your credit utilization ratio. The exception is if you open a new balance transfer credit card account to get better interest rates. This transfer strategy won’t increase your credit balance, but it may help you pay down your debt faster.

Keep in mind, however, that opening new lines of credit can also negatively impact your credit score by creating more hard inquiries on your credit report.

Does Closing Credit Cards Improve Your Credit Utilization?

Unless you absolutely need to, it’s not recommended to close your credit card. First, closing your credit card can lower the amount of credit you have available. Secondly, you could lose the history attached to the card.

The age of your credit history represents up to 15% of your overall credit score for FICO. So, keeping an account open, even if you have a very low balance on it, can help to improve both your credit utilization and your credit score.

Sign up for Credit.com’s ExtraCredit today to access FICO scores, reports from all three major credit report agencies, and more.

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