What Is Credit Utilization & How Does It Impact My Credit Score
Did you know there’s more to your credit score than on-time payments? There are five factors that usually go into this financially influential three-digit number: payment history, credit utilization, length of credit history, credit mix, and new credit inquiries. All factors are crucial, but we’re going to focus on credit utilization and its impact on your score.
What Is Credit Utilization?
Credit utilization measures how much of your available revolving credit you’re using, and maintaining a lower ratio can demonstrate responsible credit management to lenders. Revolving credit includes accounts like credit cards, personal lines of credit, home equity lines of credit (HELOCs), etc. It is where a lender lets a person borrow up to a set limit, repay the balance, and borrow again. Generally, fixed-payment loans, such as mortgages, auto loans, and student loans, do not affect credit utilization.
How Is Credit Utilization Calculated?
The basics: if you have a credit card with a $5,000 limit and carry a balance of $1,000, your credit utilization on that card is 20%. To calculate this ratio, the formula is: Credit Utilization = (Total Credit Card Balance / Total Credit Limits) x 100
Show Me The Math
How is credit utilization calculated with more than one revolving line of credit? Let’s say you have the following:
- Credit Card A: $5,000 limit with a $500 balance
- Credit Card B: $3,000 limit with a $900 balance
- Personal Line of Credit: $2,000 limit with no balance
Your total available credit is $10,000, and your total balance is $1,400. Dividing $1,400 by $10,000 gives you 0.14. Multiply it by 100 to turn it into a percentage and utilization ratio of 14%.
Note: Some credit scoring models may consider both your overall utilization across all revolving accounts and the utilization on each individual credit card. Even if your total utilization is low, having one card that's nearly maxed out could still affect your credit score.
Why Does It Matter?
Lenders use your credit score to assess how likely you are to repay borrowed money. Credit utilization helps paint a picture of how you manage available credit.
A high utilization ratio may indicate that you're relying heavily on borrowed funds, which can suggest a greater lending risk. Conversely, lower utilization generally signals that you're using credit responsibly and managing debt effectively.
While payment history is typically the most influential factor in determining your credit score, credit utilization is also a significant component. Keeping your utilization low can contribute to a stronger credit profile over time.
FAQs
Does paying off my credit card improve my credit utilization? Yes. Paying down your credit card balance lowers your credit utilization ratio. Just be sure to keep the credit card open. Closing the account could negatively impact your credit score.
What is the ideal credit utilization ratio? Many financial experts recommend keeping your credit utilization below 30%.
How often is credit utilization updated? Credit card issuers typically report account balances to major credit bureaus once a month, often after your monthly billing statement closes. Your credit utilization may change each time updated information is reported.
Can increasing my credit limit lower my credit utilization? Yes, as long as you don’t increase your spending. A higher credit limit increases your available credit, which can reduce your credit utilization ratio if your balances stay the same.
Credit utilization is an important factor in your overall credit score, but it's also one you can actively manage. By keeping your balances low, making payments on time, and using credit responsibly, you can build a stronger credit profile and improve your financial opportunities over time.