What Is Credit Utilization & How Does It Impact Credit Score?
Credit utilization is a major factor that impacts your credit score. While most of us have heard the term, “credit utilization,” many of us do not fully understand what this term means and how big of a role it plays in determining your score. This article will answer the top questions surrounding credit utilization, including:
- What is credit utilization?
- How is credit utilization calculated?
- How does credit utilization impact credit scores?
- How can I improve my credit utilization?
Top Questions About Credit Utilization
Question 1: What Is Credit Utilization?
Answer: Credit utilization is the ratio between the balance across all of your credit accounts and your total credit limit across all of your accounts. This ratio displays to lenders how much of your total available credit you are using.
Question 2: How Is Credit Utilization Calculated?
Answer: To calculate your credit utilization, you need to know your credit limit and current balance of every credit account you have. After you have this information, you must add up the credit limits across all of your cards, and then separately add up all of the balances. Once you have your total limit and total balance, you divide your total balance by your total credit limit and multiply by 100 to get a percentage.
Credit Utilization Formula
Credit Utilization= Total Balance/Total Credit Limit x 100
Below is an example to increase your understanding.
Calculation: $11,000/$26,000=.42 x 100 = 42%
In this scenario, your credit card utilization would be 42%. While this isn’t a horrible ratio, we recommend you try to keep your credit card utilization at or below 30%. When it comes to credit card utilization, the lower the percentage the better.
Question 3: How Does Credit Utilization Impact My Credit Score?
Answer: There are five elements that make up your credit score:
- Payment History (35%)
- Credit Utilization (30%)
- Length of Credit History (15%)
- Types of Credit (10%)
- New Credit (10%)
As you can see, credit utilization is the second largest contributing factor to your credit score. Why is this so? If you are maxing out your credit lines, it’s a good indication to lenders that you are spending beyond your means, and they will therefore put you in a higher risk category. On the contrary, if you have a lower credit utilization ratio, lenders will assume you have your spending under control, and thus pose less of a financial risk.
Question 4: How Can I Improve My Credit Utilization
Answer: The below tips will help you lower your credit utilization ratio.
- Make Multiple Payments: Something most consumers don’t know is that credit card issuers only report balances to the credit bureaus once a month. Thus, if you normally pay your balance off in full, but your credit card issuer submits the data before the end of the billing cycle, it could appear as though you always have a large balance on your card. Making multiple payments throughout the billing cycle can help you avoid this.
- Avoid Closing Credit Cards: It’s tempting to close credit accounts that you no longer use; however, doing so could have a negative impact on your credit utilization and credit score. Closing unused accounts will lower your available credit, and thus increase your utilization ratio. Unless a card has an annual fee, we suggest leaving it open to avoid increasing your credit utilization.
- Request A Limit Increase: Requesting a limit increase from your credit card issuer could help to improve your credit utilization ratio by increasing your total limit. By increasing your total limit, you can decrease your utilization as long as you do not go out and spend more. You should only request a limit increase if you are able to keep your spending under control.
- Set Up Balance Alerts: An excellent way to keep track of your spending is to set up balance alerts via text message or email to alert you when your spending has reached a certain level. Often times, you can request to be notified when your balance reaches a certain percentage of your available credit.
For some additional tips on how to improve your credit utilization, check out this article by Nerd Wallet!
After reading this article you should have a solid understanding of how much credit utilization can impact your credit score. As a rule of thumb, you should aim to keep your credit utilization as low as possible if you are serious about credit repair. We understand life happens. There will be instances where you are required to spend more than you would like. If you are facing a major financial expense, consider applying for a personal loan rather than swiping your credit card. Personal loans often have lower interest rates, and are not viewed as a revolving credit. For additional tips on credit and lending view the Launch FCU Blog.
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