Understanding Credit Utilization

Credit Utilization and Your Credit Score

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There are five major factors that influence your credit score: payment history (35%), level of debt/credit utilization (30%), age of credit (15%), mix of credit (10%), and credit inquiries (10%). Credit utilization has a big influence on your credit score, but what is it and how can you manage it to get the best credit score?

What is Credit Utilization?

Credit utilization is the ratio of your credit card balances to credit limits.

For example, if your balance is $300 and your credit limit is $1,000, then your credit utilization for that credit card is 30%. To calculate your credit utilization simply divide your credit card balance by your credit limit then multiply by 100. The lower your credit utilization, the better. That shows you're only using a small amount of the credit that's been loaned to you.

Your credit score - including your credit utilization - is calculated based on the information on your credit report. Because credit card information is updated on your credit report monthly and not real time, your credit score may not reflect the most recent changes to your credit card balance and credit limit. Instead, the balance and credit limit as of your credit card account statement closing date are what's used to calculate your credit score.

How Credit Utilization Factors Into Your Credit Score

The FICO scoring model looks at your credit utilization in two parts.

First, it scores the credit utilization for each of your credit cards separately. Then, it calculates your overall credit utilization, that is, the total of all your credit card balances compared to your total credit limits. A high credit utilization in either category can hurt your credit score.

Credit utilization is 23% of the VantageScore, another type of credit scoring calculation, but the score also considers your balances as 15% and available credit as 7% of its score.

In total, the amount of your credit card debt affects 45% of your VantageScore.

Why Is a High Utilization Bad?

Remember that the purpose of a credit score is to gauge the likelihood that you will repay the money you borrow. Certain factors make us all more likely to default on credit obligations. One of those factors is high credit card and loan balances. Higher balances are more difficult to afford and could indicate that you're overextended. Your credit score adjusts to high utilization to show prospective lenders that there's an increased risk of you falling behind on payments.

Keep Your Utilization Low

You can't trick the FICO score into thinking your credit utilization is low by paying your balance in full at the end of each month. If your balance is high when your issuer sends your account information to the credit bureaus, then the credit utilization used in your credit score will also be high.

Fortunately, you can maintain a low credit utilization by keeping a low credit card balance - below 30% of your credit limit is best. To ensure your credit report reflects a low credit card balance, make sure your balance is low by your account statement closing date (the date your billing cycle ends).

Check a recent copy of your billing statement to gauge your next account statement closing date.

If, for some reason, your card issuer cuts your credit limit, it's important to reduce your credit card balance to lower your credit utilization. This is especially true if your lower credit limit is at or near your credit card balance.

Fortunately, a high credit utilization won't hurt your credit score forever. As soon as you reduce your credit card balances (or increase your credit limits), your credit utilization will decrease and your credit score will go up.