What is Credit Utilization? A Look at One of the Key Components of Your Credit Score

If you’ve ever gone on a shopping spree, you know how easy it can be to spend more than you planned. Sometimes, I can’t resist going over my budget at a store like Target. Hey, it’s not my fault; they set up stores like that on purpose. 

But as with most things, moderation is the key to success. That is especially true when using credit cards. In fact, if you can’t moderate your spending, you’ll ruin one of the key metrics in your credit score: credit utilization.

Credit utilization refers to the total amount of available credit a consumer uses on their credit card and other lines of credit. Your credit utilization ratio represents that utilization as a percentage.

Credit utilization measures how much of your available credit limit you are currently borrowing against. It is often presented as a percentage, which is referred to as your credit utilization ratio.

Using some of your available credit and paying it off is a good way to build your credit history. But using too much of it can also come with unwanted consequences, including damage to your credit score.

Understanding your credit utilization is the first step to maintaining a positive credit history and qualifying for financing opportunities. Luckily, I can share plenty of tips on how to manage your credit utilization.

Believe it or not, how you approach your credit limit usage can have lasting effects on your credit score. Although credit card issuers encourage credit use, too much usage can turn into a trap. 

Below, I’ll explain the relationship between credit utilization and credit scoring. 

Credit Utilization in FICO and VantageScore

How you use your credit can lead to long-term consequences or benefits, which can appear in the form of a good or bad credit score. So your financial habits matter, but how?

Multiple factors, including payment history and age of credit lines, go into building an excellent credit score and history. As it happens, your approach to your credit utilization also plays a major part in achieving a good credit score. 

FICO and VantageScore are two of the most popular credit scoring models in the credit industry. Out of the five metrics they use to calculate credit scores, credit utilization ranks as one of the top components. 

Overall credit utilization and per-account utilization can influence your credit score. The credit account with the highest utilization will have the most impact out of your accounts. So it’s good to know the credit utilization ratio of not only all your accounts collectively but also individually. 

Of course, to be on the right side of your credit history, you must learn how to calculate your credit utilization ratio. Thankfully, this calculation isn’t rocket science. The formula involves dividing the outstanding balance on your card by your credit limit. 

I’ll give you an example of CUR in action. Suppose you have a $2,000 credit limit. You’re halfway through the month and have spent $1,000 using your credit card. With the CUR formula, you calculate that you have 50% of your credit limit. So your CUR is 50%.

In the FICO scoring model, credit utilization carries substantial weight. It is included in the “amounts owed” metric FICO uses, which counts for 30% of your score. 

As for VantageScore, credit utilization counts for 20% of its calculation model — second only to payment history. No matter the scoring model, how much you use of your credit limit can greatly impact the trajectory of your credit score.  

The Ideal Credit Utilization Ratio

Rewards and other benefits might encourage you to use your credit card frequently. But you might want to pump the brakes if your credit utilization ratio goes above a certain threshold. 

Don’t get me wrong. You don’t have to shy away from using your credit lines since payment history is the highest-ranking factor in calculating credit scores. 

However, there is a generally accepted utilization ratio that can help you maintain a better credit score. And that ratio is (drumroll please)… 30%. 

Although 30% is a good ratio to remember, according to FICO, the lower your CUR, the better that is for your score. 

Here are a couple of examples of how different credit utilization ratios can help or hurt your score:

• A 90% CUR can reflect financial stress or the inability to repay borrowed money on your part. Maxing out your cards can be viewed as irresponsible behavior and affect your creditworthiness. A 90% CUR will most likely hurt your credit score.
• A 25% CUR is right below the 30% threshold, but it is equally ideal for credit score calculations. This ratio is not too low or high, showing that you use your credit responsibly. 

Maintaining a balanced CUR at or below the 30% threshold can help you and your credit score in the long run. It also reflects your credit responsibility, showing that you are trustworthy with borrowed funds. 

Consequences of High Credit Utilization

Let’s take a deeper look at high credit utilization and how it can impact your credit score. High credit utilization can make life difficult in more than one way. Not only can it cause your score to dip, but it can also make paying off your balances harder. 

Accumulating a large balance can lead to problems. For instance, you may not be able to pay on time or have to pay high interest charges, making your credit bill even higher. 

Your credit utilization ratio can still negatively affect your credit score even if you pay off your entire balance by the due date. What matters is the current balance on your credit report at a certain time each month. So your report may show another ratio that is not 0%, depending on when you pay off your outstanding balance. 

High utilization can also impact your future borrowing opportunities and long-term financial health. Here’s how.

Maintaining an appropriate CUR has more benefits than you think. Beyond helping your credit score, it can also influence your loans, mortgages, and other financing options.

Through my research, I learned how credit utilization can impact your financing opportunities. I’ll share the must-have insights below. 

Loan Approval and Credit Card Offers

When you apply for a loan or a credit card, your lender usually looks at your entire credit report, not just your credit score. 

Your credit score serves as a snapshot to help lenders determine how likely you will repay borrowed money, but it doesn’t tell the full story. Viewing your credit report allows lenders to develop a complete profile when assessing your loan application. 

Credit utilization is one of those factors lenders examine to determine not only your creditworthiness but also your overall financial responsibility. Evaluating your utilization allows lenders to see two things: your reliance on credit and your ability to manage your finances. 

How does low or high utilization affect your chances of approval exactly?

Low utilization creates a picture of a responsible borrower. It shows that you are not reliant on credit for your payments and have good control over your finances. Someone who has low utilization also depicts that they can pay their bills on time and manage their credit responsibly.

On the other hand, high utilization shows the opposite. Borrowers with high utilization ratios are more likely to be overextended or have trouble paying their credit bills. 

With a lower utilization ratio, you are more likely to be approved by a lender, barring any other issues within your credit history. Lenders will view you as a low-risk borrower because you’re less likely to default on your loans since you typically use a small amount of your available credit.

Interest Rates and Terms

Taking care of your credit may seem tedious and boring. But you will reap the benefits later if you manage it well. And you can see this in practice when applying for loans and credit cards. 

If you’ve ever applied for credit, you may know about a credit inquiry. A credit inquiry is when someone requests your credit information. Through this process, a lender will check your credit score and history to decide whether to approve you and/or determine your loan terms. 

The terms you receive for your loans and credit cards heavily depend on your creditworthiness and credit history. 

This is where credit utilization comes in again. We already covered that an applicant with a low utilization ratio has a higher chance of getting approved for a loan or credit card. But what happens if you have high utilization and get approved for a line of credit?

First off, congratulations. But let me explain some key information you should know. A lender may overlook high credit utilization where approval is concerned. But it will take it into consideration when drafting up your terms and conditions. 

Consumers with high credit utilization usually have lower credit scores. And low credit scores will cause you to be perceived as a higher-risk borrower. So that means lenders will stick higher interest rates on your loans and credit cards, causing you to pay more over time. 

Low utilization allows borrowers to receive more favorable terms due to lenders perceiving them as a lower risk. Let’s say you have a CUR of 16%, which helps you maintain a pretty solid credit score. You think it’s time to replace your old car, so you take a trip to the dealership. 

When applying for your car loan, your lender sees that you have a great credit score and history. The lender goes on to offer you a loan with lower interest rates because they feel confident that you will repay the loan without any trouble based on your prior credit history. 

As the example above shows, credit utilization doesn’t only play an individual role in securing favorable lending opportunities. Since it affects your overall credit score and history, maintaining low utilization can give you an edge in a variety of ways. 

Although it may take weeks, months, or even years to develop a good score, all it takes is one error or mistake for your credit score to dip. That’s why consistent financial habits are so important, even though they may seem small.

As it happens, getting your credit utilization under control can make a world of a difference to your credit score. In this section, I’ll share actionable tips and strategies to help you maintain a healthy credit utilization ratio. 

Pay Down Your Balances

One of the most practical ways to maintain a low CUR is to pay off your balances regularly. Your credit utilization is based on how much of your available credit that you are using. By paying off your balance, you can reduce your balance and have a lower utilization rate. 

What’s good is that you don’t even have to pay your balance off completely. That’s why most credit scoring models like to see a CUR at 30% or under, so you have some room to carry a balance. 

It matters when you pay down your balance, though. I recommend you do it early because credit card issuers and lenders typically report your account balance to credit bureaus at the statement closing date of each month. So for it to count toward your credit score calculations, you need to reduce your utilization by a certain time each month. 

Another strategy you can employ is prioritizing your high-interest debt to manage balances effectively. This will help you with your overall financial health. 

High balances that also carry high interest can cost you a lot of money. Paying off this type of debt can help you save money over time and lower your utilization ratio — like killing two birds with one stone. 

Increase Credit Limits

Credit limits have everything to do with your utilization rate. How much available credit you have can make it either easier or more difficult to achieve a solid CUR.

It doesn’t take much for a consumer with a lower credit limit to have a high CUR. For example, imagine you have a $300 credit limit. If you spend $150, you’re already at 50% utilization rate. That’s a trip to the grocery store for some families. Compare that to a $3000 limit, and you’ll have a lot more breathing room before you hit the danger zone.

With a higher credit limit, you don’t have to be as watchful with every dollar you spend with your credit card.  

Increasing your credit limits may seem like an obvious solution. But actually doing so can be easier said than done. Oftentimes, requesting a limit increase requires a credit check, which can affect your credit history and score.

Thankfully, this impact is temporary, especially if you avoid too many hard inquiries. Depending on the credit card issuer, your request may also result in a soft inquiry, which doesn’t harm your score at all. 

Here are a few tips to consider to help your approval odds:

• Make sure your credit card balance is regularly paid off. Your credit issuer will most likely grant your request if you have a good payment and credit history.
• Have a reason why you need a credit limit increase — such as a new job with a higher salary that will require more travel spending.
• Request your increase at the right time. Try to ask for a limit increase when you receive a raise, your credit score improves, or you have paid off other debts. 

Requesting a credit limit increase is almost like applying for a credit card or loan. So, your credit responsibility and trustworthiness will always play a role in securing it. 

Keep Low Utilization on Multiple Cards

Those who own multiple credit cards can keep utilization low with careful planning.

Spreading your expenses across multiple cards can also help you maintain a low utilization rate. This strategy is important because it can help you avoid having an account with a very high CUR, which can impact your overall credit utilization and credit score.

Monitoring each card’s utilization can make it easier to keep your utilization low. You can track your statements with a mobile app or online to see which card needs to be scaled back or which one you can use to make a larger purchase without throwing off your overall CUR.

Now it’s time to debunk some myths about credit utilization. Believing common misconceptions about credit utilization can cause you to make some serious mistakes, which can carry lasting effects. Below, I’ll go through the top three myths about credit utilization. 

Closing Unused Credit Cards Helps Your Score

Closing unused credit cards may seem like a good idea on the surface. You’ll have fewer cards to worry about and manage. But it doesn’t work the way you think. 

Canceling unused credit cards can actually increase your overall utilization ratio. How? Well, it will cause the total amount of your available credit to decrease, making it easier for you to use up more of your limit.   

Keeping old accounts open can positively affect your length of credit history, which is good for your credit scores.

Credit history and age of credit accounts are contributing factors in calculating your credit score. So the older your credit history is, the better your credit score will be.

Carrying a Balance Improves Your Score

Warning: believing in this next myth can lead to adverse outcomes. Let me tell you about it. 

In the consumer finance world, there is a misunderstanding that carrying a balance improves your score. But that can’t be any further from the truth. Carrying any type of balance can cause lenders to charge you interest. It can also cause you to have a higher CUR. 

If you need to build credit, there are other ways to do so without carrying a balance. Try to stick to these financial habits: pay credit bills on time and in full, keep your old cards active, and diversify your credit accounts. Read this CardRates guide to learn more about these strategies and how employing them can help your credit score down the line.  

Checking Your Credit Hurts Your Score

I often hear the misconception that checking your credit report can negatively impact your credit score. But I’m here to tell you that this notion is simply false. 

Checking your credit report can actually help you build your credit score by educating you on your credit profile and pointing out what areas you need to improve. 

It also doesn’t cause any harm to your credit score because it is what’s called a soft inquiry. Unlike hard inquiries, which are mostly done by third-party lenders, soft inquiries are hidden from other people on your credit report. 

Regularly monitoring your credit report can also enable you to identify errors. Sometimes, inaccuracies can appear on your credit report in the form of outdated information, incorrect reporting, or unauthorized accounts due to identity theft.

If you spot an error, you can dispute it and have it either verified, removed, or corrected by contacting your lender or a credit reporting agency. You can visit AnnualCreditReport.com to obtain free copies of your credit report as often as once a week.

You may be tempted to use your credit limit to the fullest. But keeping your credit utilization under control is where the true benefits lie. Lower credit utilization allows you to build better credit and score higher approval odds for credit cards and other lending opportunities.

A good CUR is important to any financial lifestyle. That means learning how to calculate your CUR and monitoring your utilization will definitely lead you down the right path.