What is Credit Utilization and Why it Matters

Your credit utilization is one of the most important aspects of your credit score.

Indeed, after your payment history, your credit utilization is the most important factor influencing your credit score.  For most people, credit utilization means the amount of available credit being used on a credit card.

What is Credit Utilization?

Simply put, credit utilization is the amount of money you are using on your credit card.  Your credit utilization is usually added up to include all of your credit accounts, and represented by a percentage.

Let’s say you have three credit cards:

  • Credit Card A: Credit line of $3,000, and a balance of $2,500
  • Credit Card B: Credit line of $2,000 and a balance of $1,800
  • Credit Card C: Credit line of $1,500 and a balance of $700

When all of the information is added up, you end up with with your credit utilization.

The total available credit in the above example is $6,500, and the balance used is $5,000.

To get the credit utilization, you divide how much credit you have used by your credit limit.  In this case, the credit utilization is 0.7692, or about 77% ($5,000 divided by $6,500).

In this example, the person is using up 77% of his or her available credit.  This means that only 23% is available for use.

Because 30% of your credit score is based on your credit utilization, it is important to pay attention to your credit utilization — and keep it lower.

How Credit Utilization is Viewed by Creditors

credit utilization
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Your credit utilization is an important factor of your credit score.

Your credit utilization is one of the indicators that creditors use to determine whether or not you are an acceptable credit risk.  It accounts for such a large portion of your credit score because it is seen as an indication of how much credit you can handle.

If you have a high credit utilization, you are seen as unable to handle as much new credit.  After all, you already aren’t paying down the amount of debt you have right now.

Should a creditor risk overwhelming you — and possibly losing money — by giving you even more credit?

The ideal credit utilization is usually to keep it to right around 30% or less of your available credit.

In the above example, the credit card user would need to reduce the total credit being used to $1,950 to reach 30% credit utilization.  This level of credit utilization usually indicates to creditors that you are able to handle your debt payments, and that you aren’t running up bills you can’t pay.

So the way a creditor can judge your utilization, as well as the rest of your credit factors, is to put it into a score — your credit score.

When your credit utilization is high you will find that it lowers your credit score.

This means that if you are looking for additional credit, like you might if you were looking for a mortgage/refinance or looking for a car loan, you won’t have access to the best rates available (and in some cases you might not be able to get the credit you need).  With a lower credit score you also miss out on the best credit cards and the perks they give consumers as well.

It may seems odd that in order to get credit you need to not use your credit, doesn’t it?

But a lender sees it more like how close are you to the danger zone?  When you use a lot of your credit you get closer to either maxing out your credit and/or not being able to pay it off.  So a creditor has no problem with you having a lot of credit so long as you aren’t using too much of it.

Of course, the best practice is to pay off your credit cards each month so that you aren’t being charged interest on your purchases.

Even so, though, if you use your credit cards a lot you might find that your credit utilization is negatively impacted.  It all depends on when, during the billing cycle, the information is reported to the credit bureaus.  If you use your credit card for everything, and pay it off every month, if your creditor reports at the point just before you pay off your balance, your credit utilization can look deceptively high.

Watch those limits on your cards and your spending, especially if you are making a major purchase that will require a credit check (or anything else that would require a credit pull).

As always, the ideal credit score requires planning and work.  Consider your credit utilization, and what your credit habits look like to those who lend you money.

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Published or updated August 9, 2012.

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