Credit utilization is the percentage of your available revolving credit that you are currently using. It is an important factor in many credit scoring models and can influence how lenders evaluate your credit profile.
Understanding credit utilization can help you manage credit cards more effectively. A lower utilization ratio generally indicates that you are using a smaller portion of your available credit, while a high ratio indicates that you are using a larger portion.
Credit utilization is relatively simple to calculate, but several factors can affect how it appears on your credit reports.
How Credit Utilization Is Calculated
The basic credit utilization formula is:
Credit Utilization = Total Credit Card Balances ÷ Total Credit Limits × 100
For example, suppose you have one credit card with a $5,000 credit limit and a $1,000 balance.
Your utilization would be:
$1,000 ÷ $5,000 × 100 = 20%
This means you are using 20% of your available credit.
If you have multiple credit cards, you can calculate your overall utilization by adding all your card balances and dividing that amount by the combined credit limits.
For example, if your cards have a combined limit of $10,000 and combined balances of $2,500, your overall credit utilization is 25%.
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Why Credit Utilization Matters
Credit utilization can influence credit scores because it provides information about how heavily you are relying on revolving credit.
A high utilization ratio can indicate that you are using a large portion of your available credit. A lower ratio generally shows that more credit remains available.
Credit scoring models can consider both overall utilization and utilization on individual credit cards. As a result, managing each card’s balance can be important rather than focusing only on your overall percentage.
What Is a Good Credit Utilization Ratio?
There is no single utilization percentage that guarantees a particular credit score. However, lower utilization is generally preferable when managing revolving credit.
Many consumers use 30% as a general guideline, but it should not be viewed as a universal cutoff. For example, someone using 29% of available credit is not automatically in a better position than someone using 31%.
If your goal is to maintain a strong credit profile, keeping balances relatively low compared with your available limits can be helpful.
Credit Utilization and Your Credit Score
Credit utilization is one component of many credit scoring systems. Its impact can vary depending on the scoring model and the rest of your credit history.
For example, someone with a long history of on-time payments may have a different overall credit profile from someone with limited credit history, even if both people have the same utilization ratio.
Credit scores can also change as reported balances change. A high balance reported during one billing cycle may affect your utilization, while a lower balance reported during the next cycle can result in a different ratio.
Statement Balance vs. Reported Balance
Many people assume that their credit utilization is based on the balance they carry after the payment due date. However, credit card issuers can report account information to credit bureaus at different times.
In some cases, the reported balance may reflect the balance on or around the statement closing date.
This means you could pay your credit card in full by the due date and still see a balance reported to a credit bureau if the issuer reported before your payment was processed.
The specific reporting practices vary by issuer.
How to Lower Credit Utilization
One of the most direct ways to lower utilization is to reduce your credit card balances.
Paying down existing balances decreases the amount of revolving credit you are using. If you cannot pay the entire balance immediately, making additional payments during the billing cycle may help reduce the balance that gets reported.
Another option may be requesting a higher credit limit. If your balance stays the same while your credit limit increases, your utilization ratio decreases.
However, a credit-limit increase can depend on your issuer’s approval criteria and may involve a review of your credit profile.
Multiple Credit Cards and Utilization
Having multiple credit cards can affect both individual and overall utilization.
Suppose you have two cards. One has a $1,000 limit with a $500 balance, while the second has a $9,000 limit with no balance. Your overall utilization would be 5%, but the first card would have a 50% individual utilization ratio.
Credit scoring models may consider both overall and individual card utilization, so keeping one card heavily utilized may still matter even when your overall percentage appears low.
Does Closing a Credit Card Affect Utilization?
Closing a credit card can reduce your total available credit. If you continue to have balances on other cards, closing an account could cause your overall utilization ratio to increase.
For example, suppose you have $2,000 in balances and $10,000 in total credit limits. Your utilization is 20%.
If you close a card with a $5,000 limit while keeping the same $2,000 balance, your available credit could fall to $5,000. Your utilization would then become 40%.
This is one reason to consider the potential effect on your credit profile before closing an unused credit card.
Credit Utilization on Secured Credit Cards
Secured credit cards can also have a utilization ratio. The security deposit typically determines or supports the card’s credit limit, depending on the issuer’s terms.
For example, if a secured card has a $500 credit limit and you have a $100 balance, your utilization is 20%.
The same basic principles apply: keeping balances manageable relative to the credit limit can help maintain lower utilization.
Does Credit Utilization Reset Every Month?
Credit utilization can change from one reporting period to another because your balances and available limits can change.
For example, a card might report a $2,000 balance one month and a $500 balance the next month. If the credit limit remains unchanged, the utilization ratio will also change.
This means a temporary increase in utilization does not necessarily become a permanent part of your credit profile. Once a lower balance is reported, your utilization can decrease.
Final Thoughts
Credit utilization measures how much of your available revolving credit you are using. It is calculated by dividing your credit card balances by your total credit limits and multiplying the result by 100.
Keeping credit card balances relatively low can help you maintain a healthier credit profile, while high utilization can negatively affect some credit scores.
To manage utilization, consider paying down balances, making payments before balances are reported, avoiding unnecessary credit card debt, and being cautious about closing accounts that provide substantial available credit.
Most importantly, credit utilization is only one part of your overall credit profile. Consistent on-time payments, responsible borrowing, and monitoring your credit reports are also important aspects of effective credit management.
