Paying bills on time can help your credit score. But something that’s less commonly known is the power of your credit utilization.
If you haven’t heard the term “credit utilization” before — we’re here to break down what you need to know.
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What is a credit utilization rate (ratio)?
Credit utilization is the amount of credit you’re using on your revolving credit accounts compared to how much is available to you. In other words, credit utilization is typically calculated as a percentage of your available credit and is the amount of credit you owe.
Your credit utilization ratio can either increase or lower your credit score. Keeping your credit utilization low can help protect your credit score.
Let’s say, for example, that you have $4,000 in available credit on your credit card. If you’re carrying a balance of $2,000, then your credit card utilization percentage is 50%. If you owe $1,000, your credit utilization is 25%.
How does credit utilization rate affect your credit score?
High credit utilization can hurt your credit, as it suggests you may be overextending yourself financially. Keeping your credit utilization low can improve your credit score, or at least help keep it the same. That’s because a low credit utilization score tells lenders you don’t need to rely on credit to stay afloat financially.
How your credit utilization affects your credit score will depend on the specific type of credit score. If you are looking at The FICO® scoring model, your “amounts owed” (which determines your credit utilization) make up 30% of your credit score rating.1
When considering your loan or line of credit application, lenders look at your amounts owed and your credit utilization ratio on your revolving accounts (including credit cards) to assess risk.
A low ratio appeals to a lender, but a high ratio can make you look like a risky candidate for a loan or line of credit.
In other words, lenders want to know you have some restraint and won’t use all the credit available to you immediately.
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How much of your credit should you use?
A general guideline is to stick to a credit utilization ratio of 30% or below.2 For example, if you have a $1,000 credit limit, try to carry a balance of less than $300.
For better results, you might want to use less. According to credit bureau Experian, “People with exceptional credit scores (800 or higher on the FICO® Score range of 300 to 850) tend to keep utilization under 10% for each card and for total credit card use.”2
How to calculate your credit utilization rate
The FICO scoring model looks at your credit utilization in two parts. First, it scores the credit utilization for each of your credit cards separately. Then, it calculates your overall credit utilization – the total of all your credit card balances compared to your total credit limits. A high credit utilization in either category can hurt your credit score.
Here’s how to calculate your credit utilization:
- Add up the balances on all your credit cards
- Add up the credit limits on all your cards
- Divide the total balance by the total credit limit
- Multiply by 100 to see your credit card utilization percentage
For example, let’s say you have the following credit card balances and credit card limits:
| Credit card | Credit card balance | Credit card limit |
| 1 | $1,350 | $3,000 |
| 2 | $489 | $2,000 |
| 3 | $911 | $1,000 |
| TOTAL | $2,750 | $6,000 |
After adding up the total balance ($2,750) and the total credit limit ($6,000), you then divide $2,750 by $6,000, which gives you .46. Multiply that number by 100 to get your credit utilization percentage, which in this case would be 46%.
If you need to figure out the credit limits on your credit cards, log into your accounts online or call the credit card company. You can check your credit card balance through your online account or on your credit card statements.
What is a good credit utilization ratio?
The lower your credit utilization, the better. It’s generally advised to keep your credit utilization under 30% to protect your credit score and avoid raising red flags to prospective lenders.2 Aim for a 10% or lower credit utilization ratio if you want an exceptional credit score.
If you max out your credit card and pay it in full every month, you won’t pay interest. But it won’t help your credit utilization, as you are using up all of the credit available to you. Remember, your credit utilization is the percentage of your credit limit you’re using, not whether you are making on-time payments.
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Does closing a credit card affect credit utilization rate?
You reduce your total credit limit when you close a credit card account. If you owe nothing on your credit cards, your credit utilization rate is zero. However, if you keep a balance on your cards, your credit utilization could go up.
For example, if your overall credit limit is $12,000 and you close a credit card with a limit of $3,000, your overall credit limit drops to $9,000. If you have an overall balance of $4,000 across your credit cards, your credit utilization ratio goes up from around 33% to 44%. That’s a substantial jump – 11% to be exact.
It is worth the time to do your own calculations and determine whether closing a card can have an effect on your credit considering credit utilization helps determine your credit score. If so, it may be a better idea to keep the credit card open. Otherwise, you may want to pay down your credit card balances and determine a way to ensure your credit utilization remains as low as possible.
Utilize credit wisely for your financial progress
Understanding your credit utilization and how it can affect your credit is important as you work on your financial health. Though keeping your credit utilization low isn’t the only positive action you can take, doing so significantly impacts your credit score.
Starting from scratch when it comes to your credit? Here’s how long it takes to build your credit.
