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The Expert’s Guide to Credit Utilization that Will Help Get Your Score Up

Georgia McIntyre

Georgia McIntyre

Finance Writer at Fundera
Georgia McIntyre is the resident Finance Writer at Fundera. She specializes in all things small business finance, from lending to accounting. Questions for Georgia? Comment below!
Georgia McIntyre

If you’ve ever rented a home, applied for a small business loan, or taken out a personal or business credit card, then you know how important your personal credit score is.

Yes, that seemingly arbitrary three-digit number on your credit report is something worth paying close attention to. So if you want to become an expert at monitoring your credit score, the first thing you need to do is get a handle on just what goes into your credit report.

The mix of factors that go into your credit report is, technically, a secret formula. But we aren’t totally in the dark on what’s important to maintaining a top-notch credit score. We do know that the FICO algorithm used to calculate your credit score considers 5 all important factors.

One of the most important factors that’s plugged into your credit score calculation? Credit utilization.

Just what is credit utilization? And how can you take steps to have a stellar credit utilization ratio? Use this expert’s guide on credit utilization to find out.

What Is Credit Utilization?

It’s the question at the heart of this guide, and one worth covering before we dive any further into how to boost your credit score: What is credit utilization?

Simply put, credit utilization is a ratio that shows the percentage of available credit that you’ve used. And when we say “credit,” we’re talking about any credit lines you have available—typically credit cards.

Let’s break a credit utilization ratio down… How is this ratio calculated?

Well, say you have 3 credit cards, all with set credit limits. Depending on how much you swipe your cards, you’ll have outstanding balances on these cards.

Let’s put some numbers to the 3 credit cards. Say credit card #1 has a credit line of $5,000 and an outstanding balance of $1,000, credit card #2 has a credit line of $8,000 and an outstanding balance of $2,000, and credit card #3 has a credit line of $10,000 and an outstanding balance of $4,000.

Where does this leave your credit utilization ratio? Let’s do the math.

Your total credit limit across all three of your credit cards is:

$5,000 + $8,000 + $10,000 = $23,000.

Your total outstanding balance across all three of your credit cards is:

$1,000 + $2,000 + $4,000 = $7,000.

Your credit utilization ratio is $7,000 divided by $23,000, or 30.4%.

So, putting this all together, your credit utilization ratio is simply your outstanding balances on all your credit cards divided by your total credit limit, expressed as a percentage.

How Does Credit Utilization Get Factored into Your Credit Score?

Now that you know exactly what a credit utilization ratio is, your next question is probably this: “Why does it matter for my credit score?”

Great question. To answer it, we need to first walk through what exactly goes into your credit report and FICO’s algorithm.

How is a Credit Score Calculated?

Your credit score is calculated from your credit report. But let’s take a step back. What really is a “credit report”?

Your credit report is essentially the story of your financial life, told by credit bureaus. So every time you’ve taken out a car loan, used a student loan to get through college, used a credit card, had a mortgage, or used credit to purchase something now or in the future, credit bureaus are collecting data on those experiences and putting it into your credit report.

Your credit report will show just how you took care of those financial obligations—how often you repaid in full and on time, or how often you missed repayments to your creditors.

There are 3 credit bureaus collecting data on anything money-related in your life—Equifax, Experian, and TransUnion. Each of these credit reporting bureaus serve a similar purpose, but they collect different information at different times.

For that reason, your credit report will be slightly different from all three credit bureaus. But don’t worry, here’s one thing they all have in common: the FICO credit score.

FICO has an algorithm that’s used across all 3 credit reporting bureaus to take the data from your credit report, and crunch it into a 3-digit number ranging from 350 to 800. So if your credit report walks through the ups and downs of your financial life story, your credit score gives potential lenders and creditors the quick-and-dirty version of it.

When it comes down to it, your credit score shows your creditworthiness as a borrower. It answers the question, “How likely are you to pay me back?”

FICO uses a complicated algorithm to spit out your credit score. It takes in the following 5 factors to calculate your credit score:

  • Payment history. Payment history takes up 35% of your credit score. As you can guess, if you pay on time, that’s a good thing for your payment history. The more credit lines you have open with on-time payment histories, the better your credit score will be.
  • Amounts owed. Here’s where your credit utilization ratio comes in, taking up 30% of your credit score. As a refresher, your credit utilization ratio shows your ratio of outstanding debt relative to your available credit limit.
  • Length of credit history. This accounts for 15% of your credit score, showing how long you’ve had credit accounts open. FICO takes into account the age of your oldest account, the age your newest account, and a median of them all.
  • Credit mix. Your credit mix shows the types of credit you have in use, and takes up 10% of your credit score. This can be simply credit cards, loans, retail accounts, mortgages, and so on.
  • New credit. The last 10% comes from new credit, or the number of new credit lines you have open. If you’ve opened a lot of new accounts in a short period of time, FICO will ding your credit score for it.

Now that you know what goes into your credit score, amounts owed—or your credit utilization ratio—should really be sticking out like a sore thumb. With 30% of your credit score coming from your credit utilization ratio, paying attention to your outstanding balances compared to your available credit limit is a big deal.

How Does Credit Utilization Hurt Your Credit Score?

So, your credit utilization takes up a whopping 30% of your credit score. We know that so far.

Why does it take up such a big chunk of what goes into your credit score?

Well, if you have a high credit utilization ratio—meaning you have large outstanding balances relative to your total available credit limit—lenders will think that there’s a better chance that you won’t repay your debts.

You’re borrowing this money, after all, and you’ll have to pay it back somehow. If you’re borrowing a lot of money, you’ll have a lot more to repay. These higher balances, in general, are more difficult to afford and could indicate to potential lenders that you’re overextended.

And if you look at the numbers, they do show that higher credit utilization ratios tend to correlate with lower credit scores:

2015-01-26-ccu-and-avg-credit-scores-update_graph

We got this here.

Say it with us: High credit utilization ratio, lower credit score. And your credit score will take a hit if you have no credit utilization ratio, either.

On the other hand, keeping a tab on your credit utilization ratio will help you boost your credit score. Data shows that the credit utilization ratio sweet spot is under 20% and not higher than 30%.

So, if your credit score isn’t where you want it to be, now is a great time to start monitoring that credit utilization ratio to keep your score in tip-top shape.

Best Practices for Maintaining your Credit Utilization Ratio

If you’re looking for an exact credit utilization ratio that will give you that perfect, shiny 850 credit score, you won’t find one.

Yes, we can generally say that the best ratio to have as your credit utilization is below 20%, but not higher than 30%. But to put a hard-and-fast rule on where every borrower’s credit utilization ratio needs to be just wouldn’t make sense.

For one, FICO’s scoring formula assigns credit score points to certain ranges of percentages. So if your credit utilization is 20% in one month and 25% the next, you might not see any change in your credit score due to the amounts owed category. But if a spike in your credit utilization brings you to a higher percentage range that is associated with fewer points to your credit score, then your credit score will take a hit. In general, there is no threshold credit utilization ratio that you need to stay below to avoid total disaster on your credit report.

Here’s our advice: The lower the credit utilization the better, but keep it above 0%.

With that in mind, here are a few steps that can help you take control of your credit utilization ratio.

1. Keep Tabs on How Much You’re Charging On Each Card

This first piece of advice is the most obvious one.

If your credit utilization ratio essentially comes down to the relationship between your outstanding balances on your card and your total available credit limit, then the first step is to keep your balances low!

Now, we know that reining in spending is not an easy thing to do. But start by simply monitoring your different accounts on a regular basis. That way you’ll know when you’re getting into dangerous territory before you put your next purchase on your card—not when it’s the end of the month and it’s too late to doing anything about your utilization.

Even though your credit utilization ratio is calculated by aggregating your total balances and your total credit limit, it’s important to be aware of your credit utilization ratio on each individual account you have open. Some scoring models can penalize you for having a high credit utilization ratio on any one card. So as a best practice, keep your outstanding balance low on all your cards at all times.

And finally, if you have more than one credit card account to your name but tend to only use one card, start spreading out your charges among all your cards. Doing so will help you avoid a high utilization ratio on just one card.

2. Think Twice About Closing That Credit Card Account

Credit utilization aside, it’s good for your credit score to keep your credit accounts open. Having a mix of different credit accounts and consistently practicing good borrowing behavior on each of them over time is a smart move.

But when it comes to your credit utilization ratio, we’ve got another reason why you might think twice about closing an account.

Your credit utilization ratio takes your total available credit limit into account. When you close an account, you’re taking away a portion of your total credit limit and in turn, raising your credit utilization ratio.

Say, for example, you have 2 credit cards—one with a credit limit of $1,000 and an outstanding balance of $450, and one with a credit limit of $2,000 but only an outstanding balance of $50. Your current credit utilization ratio is about 17%—not too shabby. But you don’t use that second card too much, so you decide to pay off the $50 balance and close the card. Well, without the $2,000 of available credit being factored into the ratio, your current credit utilization ratio is now 45%—not where you want it to be.

So, before you close a credit account, think about where your credit utilization ratio would be without it. It might not be too affected by the dip in your total credit limit. But on the other hand, it could really spike your ratio. Simply balancing your charges across all your credit cards, or paying off your other cards’ balances before you close an account can solve this problem. But you might want to reconsider closing any credit accounts in the first place.

3. Pay Regularly and Use Balance Alerts

Paying off your balance every month is important for a lot of different reasons.

For one, paying your balance in full every month saves you money on steep interest charges. But it’ll also help you keep your credit utilization ratio low. If you don’t pay your balance for one month, you’re giving yourself less room to make charges on your credit card while still keeping your credit utilization ratio low the next month. In a sense, you’re just adding to your existing balance, pushing your credit utilization ratio up even further.

So, make sure you’re paying your balance in full every month. And for that matter, make sure you’re paying your balance once your utilization starts to creep up to 30% for any of your cards—even if it’s nowhere near the end of the month.

For busy people, paying attention to all your credit card balances all the time can be tough. Luckily, you can set up alerts that will notify you when any of your accounts are reaching a 30% credit utilization ratio. And if you want to be even more prepared, you can set up those messages to alert you once you’ve reached a 15% to 20% ratio, so you’ll have more than enough time to pay off your balance.

4. Find Out When Your Credit Card Issuer Reports to Credit Bureaus

Remember when we said that the 3 credit reporting agencies all work a little different?

Well, most credit card issuers report your card balance and recent payment activity to credit bureaus once a month. But the credit reporting agencies request this information at different times of the month. And whatever date the issuer reports to the credit reporting bureau doesn’t have to be when your credit card bill is due. It could very well be 3 or 4 days before it’s due, and before you’ve paid your balance down.

That means that the credit reporting bureaus—the ones actually calculating your credit score—are receiving information that you’re carrying a high balance, even though you were planning on paying it off in full just 3 days later.

This problem is easily solved. Just call into your card issuer’s customer service department and ask when they report to the credit bureaus each month. Once you know that date, you can pay off your balance as much as you can before the credit card issuer reports your balance.

5. Ask for an Increase in Your Credit Limit

So, if your credit utilization ratio directly depends on your total credit limit… why not ask for a higher credit limit?

If it’s tough for you to consistently stay at a low credit utilization ratio, then requesting a credit limit increase on one or more of your cards is a pretty easy fix. If you have a good relationship with the credit card issuer—meaning you’ve consistently paid off your balances in full and on time—increasing your credit limit shouldn’t be a big issue.

While this is a way to instantly bring down your credit utilization, it only works if you don’t ramp up your spending. And with the bump in your credit line, you might be tempted to do so.

You should also be aware that in some cases, the card issuer might do another credit inquiry before they increase your credit limit. Pulls on your credit score can hurt your credit rating, so check to see if the issuer will do a hard pull on your score.

The Bottom Line of Credit Utilization

When it all comes down to it, here’s what you need to know about your credit utilization ratio: the lower it is, the better your score. And if you want to ace your credit utilization ratio, you can take those 5 easy steps to becoming an expert at managing it.

But remember: Building your credit score is a balancing act, and your score won’t climb overnight. It’s all about being aware of your credit activity, practicing good borrowing habits, and patience.

If you follow the credit utilization ratio best practices, you’re well on your way to having a stellar credit score!

Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.
Georgia McIntyre

Georgia McIntyre

Finance Writer at Fundera
Georgia McIntyre is the resident Finance Writer at Fundera. She specializes in all things small business finance, from lending to accounting. Questions for Georgia? Comment below!
Georgia McIntyre

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