Understanding Credit Utilization

Credit utilization and your credit score

A calculator sits next to a percent sign
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Credit cards provide the ability to build a credit record and receive a credit score.

When you use credit cards responsibly, you have access to additional funds in an emergency, you can finance large purchases that might take a few months to pay off, you can earn points or cash-back rewards on your monthly spending and, in some cases, have access to services such as roadside assistance, travel plan assistance, upscale airport lounges, and concierge help while traveling.

If you have a high credit utilization on your cards, however, you might find yourself with a lower FICO score on your credit report, a more difficult time making the larger monthly payments, and a potentially higher interest rate on your cards if you make any payments late.

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 outstanding credit card balances to your credit card limits. It measures the amount of your credit limit that's being used. For example, if your balance is $300 and your credit limit is $1,000, then your credit utilization for that credit card is 30 percent.

If you’re adding $500 per month of new charges on your card and your limit is $1,000, you’ll have a utilization rate of 50 percent.

To calculate your credit utilization simply divide your credit card balance by your credit limit then multiply by 100. The lower your credit utilization percentage, the better. A low credit utilization shows that you're only using a small amount of the credit that's been loaned to you.

Five major factors have an influence on your credit score:

·        Payment history (35 percent)

·        Level of debt/credit utilization (30 percent)

·        The age of credit (15 percent)

·        Mix of credit (10 percent)

·        Credit inquiries (10 percent)

Your credit score—including your credit utilization—is calculated based on the most recent information posted on your credit report. Because credit card information is updated on your credit report based on billing cycles and not in 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 is what's used to calculate your credit score.

How Credit Habits Factor 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 percent of the VantageScore, another type of credit scoring calculation, but the score also considers your balances as 15 percent and available credit as 7 percent of its score. In total, the amount of your credit card debt affects 45 percent of your VantageScore.

Why Is Using My Card's Capacity Bad?

The purpose of a credit score is to gauge the likelihood that you will repay the money you borrow. Certain factors make people 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. High utilization lowers your credit score and signals to prospective lenders that there's an increased risk of you falling behind on payments.

Tips to Manage Your Credit Utilization Percentage

To manage your credit utilization, especially if your credit cards get a good workout each month, one of the easiest things you can do is set up balance alerts that will notify you if your balance exceeds a certain limit that you set so that you can curtail your spending if needed. Besides keeping an eye on your balances, there are a couple of other things you can do:

Spread your monthly purchase charges over different credit cards. This way you’ll have lower balances on several cards instead of a balance that uses more than 30 percent of your limit on one card. Keep in mind, though, that some credit scoring models look at your overall usage as well, so this might not always work.

Find out when your card issuer reports information to the credit bureaus and pay attention to the date you make your card payments each month. If your balance is high when your issuer sends your account information to the credit bureaus, such as a few days before the end of the billing cycle, then the credit utilization used in your credit score will also be high.

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.

Ask your credit card company to increase your card limit. For example, if you have a card with a $5,000 limit, and you’ve spent $2,500, this gives you a 50 percent utilization rate.

You can call your card issuer and ask for a limit increase and say that you have received an increase and can now charge up to $25,000. This change puts you at only 10 percent utilization, which could make a substantial difference to your credit score.  

However, if you have made a few late payments, or switched to a job that doesn’t pay as much income, your card issuer could reduce your credit limit. In this case, it's important to reduce your credit card balances to lower your credit utilization to get as close as possible to 30 percent or less utilization. This is especially true if your lowered credit limit is at or near your credit card balance.

Pay your credit cards twice each month, if you’re looking for the most low-maintenance way to keep your utilization low. This way, even if you’re using the cards throughout the month, a mid-month payment can pay the card back down to a level that stays below the 30-percent threshold.

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.