When credit scoring agencies look to your credit reports to calculate your score, they take five major things into consideration: payment history, credit utilization, credit history length, credit mix, and new credit. While payment history has the greatest impact on your score, credit utilization follows not too far behind. So what is credit utilization, and what can you do to make it work in your favor?
Also known as a credit utilization ratio, credit utilization rate is the amount of revolving credit in use compared to total revolving credit. If you’re talking about a credit card account, the rate would be the current balance on the card divided by the credit limit on the card. Credit utilization rate is typically expressed as a percentage.
Credit utilization only pertains to revolving credit — or credit that you can use, pay off, and reuse on a regular (revolving) basis. Common types of revolving credit include credit cards and lines of credit. Mortgages, auto loans, personal loans, and other types of credit that require you to pay off a set amount of money over a predetermined period of time are called installment loans; these types of credit do not count toward your credit utilization rate.
The most common credit scoring models weigh credit utilization heavily into your credit score. For FICO scores, credit utilization accounts for 30% of your credit score — behind payment history (35%) but ahead of credit history length (15%), credit mix (10%), and new credit (10%). VantageScore calls credit utilization “highly influential”.
The less of your credit that you use, the lower your credit utilization rate will be. Credit utilization has an inverse relationship to your credit score. The lower that your credit utilization rate is, the more it positively impacts your score. Conversely, the higher that your credit utilization is, the more it will negatively impact your score.
A higher rate may raise a red flag for lenders because it shows that you rely too heavily on credit, may have trouble managing your finances, and could be a liability to the lender if they approve you for a loan. A lower credit utilization rate indicates to lenders that you do a good job of managing your credit, making you a more appealing candidate for loans and low interest rates.
Popular credit scoring agencies recommend that you keep credit utilization below 30%. The recommended maximum credit utilization rate is the same for individual credit cards (per-card utilization) and total credit utilization across all cards.
For instance, if you have one credit card with a credit limit of $1,000, you should aim to put a maximum of $300 on the card.
$1,000 x 30% = $300
If you have two credit cards and Card A has a credit limit of $1,000 and Card B has a limit of $5,000 ($6,000 total credit limit), the recommended maximum balance for both cards would be $1,800 (total), with $300 for Card A and $1,500 for Card B.
TOTAL: $6,000 x 30% = $1,800
CARD A: $1,000 x 30% = $300
CARD B: $5,000 x 30% = $1,500
A high balance means that you have a high credit utilization rate. Unfortunately, a high credit utilization does reduce your credit score. The good news is that it won’t do long-term damage. If you pay down your balances, you should start to see an increase in your credit score soon.
When that increase occurs depends on credit reporting. Each month, credit card issuers report your balances and payments to the three major credit bureaus — Equifax, Experian, and TransUnion. That data will then be added to your credit reports and eventually reflected in your credit scores. Every month, you have the opportunity to see a rise or fall in your credit score, which seems to be quite often in the grand scheme of things.
It also means, however, that if you make a payment to reduce your credit utilization just after an issuer has reported your activity to the bureaus, it could be a month before those changes filter through the system to your credit reports and scores.
Since credit utilization accounts for a significant portion of your credit score, it’s important that you don’t ignore it. Adjusting your credit utilization rate could be one way to see a boost in your score, and there are a few ways that you can go about it.
You know your spending habits and credit usage best, so only take on as much credit as you are comfortable with and able to afford. If you are someone who is often tempted to pay with credit, numbers 3–5 may not be the best options for you.
It can help keep your credit utilization down and your credit score up if you have the means to pay off your credit card balance each month. When your credit card issuer reports your information to the credit bureaus, lenders will see that you have a positive payment history and are able to keep your finances in check.
If you aren’t able to make one large payment at the end of the month, break it up into smaller payments throughout the billing cycle. It will help you tackle your debt in increments, keep a lower credit utilization rate, and minimize or avoid interest payments in the event that your outstanding balance rolls over to the next month.
You may have trouble getting approved for a credit limit increase if your credit score is already low. However, if you can get approved, it is another opportunity for you to lower your credit utilization rate. It’s important to remember that an increase in your credit limit does not necessarily mean that you should increase your spending.
If you want to see a lower rate, you should increase your limit and keep your spending steady. Some credit card companies allow you to set up balance alerts that notify you when you’ve spent a certain amount each month, which could help you stay on track.
Even if you don’t plan to use them, leaving credit accounts open can benefit your credit score by lowering your overall credit utilization rate. You can put your cards to the side and avoid using them altogether, or use them for small purchases like gas and groceries. By leaving these cards open and using them minimally, you free up more available credit to count toward your credit utilization rate in a positive way.
This won’t work for everyone and should only be used if you’re able and willing to accept the short-term consequences. While new accounts will open up additional credit, it will also initially decrease your credit score due to hard inquiries on your credit report by issuers.
You also shouldn’t open a new line of credit for the sake of lowering your credit utilization, especially if you aren’t confident in your spending habits. New credit can help diversify your credit mix and lower your utilization rate if used properly, but it can also negatively affect your finances long term.
Cushion helps you waste less money, save more, and live a financially healthier life. We monitor your bank and credit card accounts 24/7, find and alert you about pesky fees, let you know which fees are negotiable, which banks are cooperative, and can even automatically negotiate on your behalf.* To date, Cushion has secured customers more than $11 million in bank and credit card fee refunds—and we’re just getting started.
*Cushion only negotiates fees with high refund odds. We cannot guarantee any negotiations, a regular frequency of negotiations, or fee refunds—your bank makes the final call.