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Many factors impact your credit score. Credit utilization, or the amount of credit used versus the total credit extended to you, is one of the most important factors impacting a credit score. Especially when you plan to use your credit to apply for a mortgage, credit card or auto loan, it remains critical to understand what credit utilization is and how it can affect your credit score.
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What Is Credit Utilization?
Credit utilization is the ratio of your overall credit balances (the amounts you currently owe to various lenders) to your credit limit (the maximum amount you’ve been approved to borrow). To calculate this rate, take the current amount you owe, divide it by your credit limit and multiply by 100.
Here’s an example: if you owe $500 on a credit card and the credit limit is $1,000, to find your utilization percentage, you’ll need to divide $500 by $1,000. That leaves you with .5. Now, you need to multiply that number by 100, which gives you 50. This means that if you carry a $500 balance on a card with a limit of $1,000, your utilization will be 50%.
What Is a Good Credit Utilization Ratio?
Traditional wisdom suggests credit scores benefit most when credit utilization remains below 30%. Those who can keep credit utilization below 10% may see even better results. In general, the lower the ratio, the better. The higher the ratio, the worse the negative impact on your credit score.
How Does Credit Utilization Affect My Credit Score?
Lenders may consider you a high risk borrower if you use more of your credit and your credit utilization rate can negatively impact your credit score if you allow it to get too high. While this is not, of course, the only factor impacting your credit, credit utilization accounts for up to 30% of your credit score.
How Much of My Credit Card Limit Should I Use?
You should aim to use no more than 30% of your credit limit at any given time. Allowing your credit utilization ratio to rise above this may result in a temporary dip in your score. Fortunately, paying it off quickly should result in your score bouncing back, although you’ll have to wait until your bank reports the new balance to the credit bureaus—depending on the bank, this can take 30 days or more.
Paying down your balance multiple times per month can also help keep your credit score lower despite a higher overall monthly credit utilization. Paying down your balance often doesn’t guarantee your credit utilization won’t rise, but it increases the odds your bank may report your card balance to a credit bureau on a day where your utilization is, in fact, lower.
How Can I Increase My Credit Card Limit?
If you find yourself using the majority of your credit limit on a regular basis, it may make sense to increase your line of credit instead. Most major credit card providers offer an option to request a credit increase online, which is the easiest option, especially if you have a relatively strong case for increasing your credit—such as a long history of on-time payments. You may also request a credit increase via a phone call to your card issuer.
You can also apply for additional lines of credit or additional cards as a means of increasing your overall credit limit. Do this responsibly—applying for too many cards in too short a period of time may also have a negative impact on your credit score.
If you want to lower your overall available credit, don’t close open accounts. Closing open accounts will reduce the amount of credit you have available to you, and thus increase your credit utilization ratio. Closing older accounts may also impact your credit score in other ways; the age of your oldest active account is a factor in evaluating your credit history and the longer your history is, the better.
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Bottom Line
Your credit utilization rate affects your credit score. Try to keep your overall credit use to about 30% of your overall credit limit, if not lower. Extend your overall credit availability by applying for additional lines of credit, but don’t apply for too many at once.
As an expert in personal finance and credit management, I have a comprehensive understanding of credit scoring mechanisms, including the critical concept of credit utilization. My expertise extends from years of research, practical experience, and advising individuals on managing their credit effectively.
Credit utilization, often overlooked by many, is a fundamental factor influencing one's credit score. It refers to the ratio of your outstanding credit balances to the total credit available to you. Maintaining a low credit utilization ratio is pivotal for a healthy credit score. In essence, it involves prudent management of available credit to ensure that your outstanding balances don't exceed a certain percentage of your total credit limit.
The article from Forbes Advisor adeptly outlines the significance of credit utilization in determining your creditworthiness. It emphasizes that keeping your credit utilization below 30% is advisable, with an even more favorable impact on your credit score if you manage to stay under 10%. The higher the ratio climbs, the more adverse effects it can have on your credit score, potentially flagging you as a higher risk borrower.
Moreover, the article touches upon strategies to manage credit utilization effectively. It suggests paying down balances multiple times a month to mitigate the impact of higher monthly utilization. Additionally, it provides insights into increasing your credit limit sensibly by requesting credit line increases or acquiring additional lines of credit. The article wisely warns against applying for numerous cards within a short timeframe, as this action can negatively impact your credit score.
It also sheds light on the importance of maintaining older accounts for a healthy credit history. Closing old accounts might inadvertently decrease your credit score by reducing the overall credit available to you and potentially impacting the length of your credit history.
In summary, the article underscores the criticality of maintaining a balanced credit utilization ratio and offers practical advice on managing credit effectively to maintain a healthy credit score. It is crucial to understand these concepts to make informed financial decisions and secure favorable terms when applying for credit, be it a mortgage, credit card, or auto loan.
