Everything You Need to Know About Credit Utilization

credit utilization

Credit utilization plays an important role in determining your credit score. That, in turn, controls your access to loans and financial opportunities. If you can leave a large portion of your available credit untouched, you’ll watch your credit score climb.

What Is Credit Utilization?

How do you eat a chocolate bar?

Do you nibble a few bites and save the rest for later? Do you enjoy half and throw the uneaten portion away? Or do you scarf down the entire chocolate bar and enjoy every bite?

The way you eat a chocolate bar isn’t too different from the way you use a credit card or, in financial lingo the way you manage your credit utilization. It’s there to eat (or spend), but it’s usually better to pace yourself.

Credit utilization is a ratio that describes how much credit you’re using versus how much credit you have. It’s expressed as a percentage, the amount of credit you have divided by the amount of money you owe.

Every time you open a credit card account or take out a loan, you increase the amount of credit you have to use. “Credit” is really just a nice way of saying “debt”, because—let’s face it—the money isn’t yours. A credit card company or lender is letting you borrow funds under the agreement that you pay them back over time.

High vs Low Utilization

If your credit utilization is high, it means that you have used most or all of the money you borrowed, but you haven’t paid much back.

For example, if you have three credit cards with credit limits of $1,000, $2,000, and $5,000, but you’ve maxed out every card, then you’re utilizing the entire $8,000 of credit available. That’s 100% credit card utilization, which will hit your credit score right where it hurts.

On the other hand, if your credit utilization is low, it means you have the ability to use your borrowed money, but you pay it back quickly or refrain from using it at all. Your credit card with the $5,000 limit might only have a balance of $700 while your other two cards sit at a nice $0 balance.

Financial institutions definitely prefer low credit utilization! Lenders aren’t too keen to let you borrow money if you demonstrate a habit of accumulating debt you can’t pay off.

Why Is Credit Utilization Important?

Credit utilization is the second most influential factor on your credit score (timely payments are the first). A full 30% of your score is determined by your credit utilization history and habits.

When you maintain low utilization, you prove that you’re not tempted to overspend or get into unnecessary debt. This boosts your credit score and opens new financial doors of opportunity.

When you continually hit high credit utilization, your credit score drops. This closes financial doors and makes it much harder to gain the trust of new lenders.

Simply put, if you want to build a strong and resilient credit score, give your credit utilization some TLC by paying down your credit cards. You can even cut the cards in half or stick them in the freezer to resist the urge to spend.

What Is the Proper Utilization Ratio?

Credit score models consider the best credit utilization rates to be below 30%. This means that you can strengthen your credit score by only using one-third (or less!) of your total available credit. If you have three credit cards with a total credit limit of $10,000, your revolving balance shouldn’t exceed $3,000. For more detail, check out this good advice on how to keep a good credit score from the U.S. government Consumer Financial Protection Bureau.

Keep in mind that your credit score probably won’t spike the same day that you make a hefty payment on your credit card bill. It takes time, up to 30 or 60 days, for credit card companies to report payments to the reporting agencies that maintain your credit history. You can trust that keeping your credit utilization rate under 30% will improve your credit score.

Don’t wait to get out of debt! Read this: A Complete, Step-By-Step Guide to Get Out of Debt.