What is credit utilization, and how does it work?

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You're getting ready to apply for a mortgage, a car loan, or a new credit card. You know your credit score will play a big role in whether you get approved and what interest rate you'll pay. But do you know what goes into calculating that three-digit number?

You might have heard that payment history is the biggest factor, but another piece of the puzzle has a major impact: your credit utilization ratio. 

In this article, we'll explore exactly what credit utilization means, how it affects your credit score, and, most importantly, what you can do to ensure that it is working for you, not against you. 

What is credit utilization? 

Your credit utilization ratio is the amount of revolving credit you currently use divided by the total amount of revolving credit you have available. In other words, it's how much you owe divided by your credit limit.

Here's a simple formula to calculate your credit utilization ratio: (Credit card balances) ÷ (Credit limits) x 100 = Credit utilization ratio

For example, let's say you have two credit cards. Card A has a $6,000 credit limit and a $2,500 balance. Card B has a $4,000 limit and a $1,000 balance.

To calculate your credit utilization ratio, add your balances: $2,500 + $1,000 = $3,500. Then, add your credit limits: $6,000 + $4,000 = $10,000. Finally, divide your total balances by your credit limits: $3,500 ÷ $10,000 = 0.35. Multiply by 100 to get your credit utilization ratio of 35%.

Why does credit utilization matter?

A high utilization rate signifies that you have a lot of outstanding debt compared to your credit lines. Since your credit score measures your level of credit responsibility, it works against you if you use too much credit at once. 

Credit scoring models, like FICO and VantageScore, use your credit utilization ratio to determine your credit score. Your credit utilization ratio is the second most important factor in determining your FICO Score, right after your payment history.

Credit utilization makes up 30% of your FICO Score. The lower your credit utilization ratio, the better it reflects on your credit score. On the other hand, a high credit utilization ratio can negatively impact your score because it indicates you're close to maxing out your credit cards, which can be a red flag to potential lenders.

Not only does excessive outstanding credit hurt your credit score, but it can also damage your financial health. Too much debt can be hard to keep up with and diminish the money you can save for emergencies, retirement, and other financial goals.

Per-card vs. overall credit utilization

Per-card utilization is the utilization ratio for each of your cards. For example, if you have a credit card with a $1,000 limit and a $800 balance, your per-card utilization would be 80%.

Your overall utilization is the total of all your credit card balances divided by the total of all your credit limits. As we saw in the earlier example, if you have balances totaling $3,500 and credit limits totaling $10,000, your overall utilization would be 35%.

Both per-card and overall utilization are important. High utilization on a single card can hurt your scores, even if your overall utilization is low. Ideally, you’d want to keep your per-card and overall utilization low.

What’s a good credit utilization ratio? 

In general, a good credit utilization ratio is anything below 30%. Of course, the lower your utilization, the better. People with excellent credit scores tend to have very low credit utilization ratios, often in the single digits.

However, don't aim for 0% utilization. Having no utilization at all can actually hurt your score because it doesn't give lenders any information about how you manage credit. A small amount of utilization, around 1-10%, is ideal to show responsible credit use without hurting your score.

Factors that affect your credit utilization

Several factors can impact your credit utilization ratio, some of which are less in your control:

• Credit card balances: The total amount you owe on your credit cards directly influences your utilization rate. Paying down balances is the most effective way to lower your utilization.
• Credit limits: If your credit limits increase while your balances remain the same, your utilization rate will decrease. Conversely, if your limits are lowered, your utilization rate will go up. Your card issuer will assign you a credit limit when you apply for an unsecured card. But over time, with a positive payment history, you may request an increased credit line or the issuer may increase it automatically. 
• Number of credit accounts: Opening new credit card accounts can lower your overall utilization by increasing your total available credit. Closing old accounts can have the opposite effect. However, what you do with the new card also matters — if you immediately start racking up debt, your ratio will increase. 
• Timing of payments and reporting: Card issuers typically report balances to the credit bureaus once a month. If you make a payment right before this reporting date, your utilization rate may be lower than if you wait until after the reporting date.

Strategies to improve your credit utilization ratio 

If you're looking to lower your credit utilization and boost your credit score, try these tips:

• Pay down your balances: Make larger payments toward your card to lower the balance. The faster you lower your balance or pay it off, the quicker your utilization ratio decreases.
• Request a credit line increase: If you have a history of on-time payments, your credit card issuer may be willing to increase your limit, lowering your utilization rate.
• Open a new credit card account: A new one can increase your total available credit and lower your overall utilization. Just be sure to use it responsibly and avoid taking on new debt.
• Spread out your credit use: If you have multiple credit cards, try maintaining low balances on each rather than maxing out a single card.
• Make multiple payments throughout the month: By making smaller payments throughout the month, you can keep your balances low and avoid high utilization when the issuer reports to the credit bureaus.
• Consider a balance transfer: If you qualify for a balance transfer credit card, consider moving your balance onto the new card and paying it off before the introductory rate expires. This will help you save money and lower your utilization rate faster.

How to monitor and track your credit utilization

Tracking your credit utilization rate is just as important as tracking your credit score. Fortunately, you can do both at the same time. Here are a few ways to stay on top of your utilization rate:

1. Check your credit reports regularly: Every week, you're entitled to one free credit report from each of the three major credit bureaus (Equifax, Experian, and TransUnion). Review these reports to see your current balances and credit limits. You can use this to calculate your credit utilization ratio. 
2. Use online banking or budgeting apps: Many banks and budgeting tools allow you to link your credit card accounts and track your balances and utilization in real time.
3. Set up alerts: Some card issuers let you set up custom alerts to notify you when your balance reaches a certain level or your utilization rate is too high.

If you notice a sudden increase in your utilization ratio, consider what may cause it. For example, did one of your card issuers close your account? Did someone fraudulently use your credit card? Understanding why your ratio suddenly increased can help you immediately fix any issues.

Frequently asked questions 

Bankrate frequently asked questions about credit utilization

What is a good credit utilization ratio to aim for?

The rule of thumb is to have a 30% utilization ratio or lower. This demonstrates responsible credit use while showing lenders that you handle your payments appropriately. Focus on your utilization ratio, overall and per card, to ensure you're on target.

Can high credit utilization permanently damage my credit score?

High credit utilization isn't a permanent problem. You can fix it quickly by paying your balance down or completely off, lowering your utilization ratio. While the change to your credit score may take a little time to show up on your credit report, it can affect your score.

How quickly does lowering credit utilization improve credit scores?

A lower utilization ratio can take over 30 days to improve your credit score. How long it takes depends on how frequently the credit card company reports to the credit bureau and how much you lower your utilization ratio.

Is it better to have one card with high utilization or multiple cards with low utilization?

A high utilization rate can damage your score if you only have a single credit card. However, if you have multiple cards and a long credit history, a high utilization rate on one card won't damage your score excessively as long as your overall ratio is within the 30% range.

The bottom line

Credit utilization may seem complex, but it boils down to using credit responsibly and keeping your balances low relative to your credit limits. 

By monitoring your utilization rate and implementing strategies to keep it in check, you can improve your credit score, borrowing power, and financial health.

Editorial disclosure: Opinions expressed are author's alone, not those of any bank, credit card issuer, or other entity. This content has not been reviewed, approved, or otherwise endorsed by any of the entities included in the post.