Credit Utilization Rate and How It Affects Your Credit

Credit Utilization Rate

Credit cards provide us with the ability to build a credit record and receive a credit score, along with so many other advantages. If you have a high credit utilization on your cards you might find you with lower credit scores, a more challenging period making larger monthly payments, and a higher interest rate on your cards if you make any late payments.

Credit utilization has a very big control on your credit scores, so you should know what it is and how you can also manage it in order to get the best credit card ratings and the advantages that come with it.

What is Credit Utilization Rate?

The credit utilization rate is the ratio of your credit card balances to your credit limits. It calculates the measure of available credit you are using. For instance, if your balance is $300 and your credit limit is $1000, then your credit utilization for that particular card is 30%.

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If you add $500 per month of new charges on your card and your card limit is $1000, then you will have a utilization rate of 50%.

To measure your credit utilization ratio, you are to simply divide your credit card balance by your credit limit, then multiply by 100. The lower your credit utilization percentage, the better.

Low credit utilization is showing that you are only using a small amount that is been extended to you.

Five main factors influence your FICO credit score in the most commonly used credit scoring model:

  1. Level of debt /credit utilization 30%
  2. Payment history 35%
  3. Age of credit 15%
  4. New credit 10%
  5. A mix of credit 10%

Your credit score including your credit utilization ratio is measured based on the most recent information, posted on your credit report. Because information about your credit card is updated on your credit.

Based on the billing cycles and not in real-time, your credit score may not reflect the most recent changes to your credit card balance and your credit limit.

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Note: Also you need to know that the balance and credit limit as of your credit card account statement closing date is what is used to measure your credit score.

Why does the utilization of your credit card affect your credit score?

Your credit utilization rate is a very important pointer to lending risk. To the eyes of most of the lenders, a person who regularly charges all the money they can_ hitting or moving over their credit limit on a regular basis is more likely to have challenges in repaying the money.

On the other hand, someone who charges smaller amounts may be more likely to be able to pay off their balance in full each month. Therefore they represent a lower risk to the lender.

How does the utilization of your credit card affect your credit score?

They are so many different credit-scoring models, so it will be challenging to calculate exactly how much credit utilization will affect your credit scores.

With that being said, there is a very strong correlation between a consumer credit card utilization rate and their credit scores. Though individual cases may differ, those that keep their utilization percentage low generally have higher scores than those who constantly max their credit cards out.

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If you do not want your credit utilization to negatively affect your credit scores negatively, seriously consider working on your spending habits or increasing your credit limit to keep your credit utilization low and build your credit.

Determinants such as your credit history and the number of cards in your wallet matter also. High utilization on a single credit card will most likely hurt your credit scores if you have a short credit history and only one card.

On the other hand, you will most likely feel the effects less, that is if you have a long and very good credit card history and spread your utilization of your credit cards across multiple cards.

Though it is a very important factor in calculating your credit scores, try not to just focus on this one area. Keep the big picture in mind.

How to Calculate Credit Utilization

All you are to do to determine each of your credit utilization ratios for a personal card is to divide your balance by your credit limit. To find out your overall utilization ratio, add up all of your revolving credit account balances, and divide the whole by the sum of your credit limits.

Credit card utilization formula:

The formula for calculating credit card utilization can be simply written as:

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Credit card balance ÷ Cards credit limit x100

Total Credit Utilization Ratio Formula:

(Credit card 1 balance + credit card balance 2 or other revolving credit line Balance, etc.) ÷ (Card 1limit + Card 2 credit limit or other revolving credit lines limit) x100

For example, having a $600 balance on a card with a $6000 credit limit would give you a 10% credit utilization rate on the card. If you happen to have two other credit cards, one with a $2000 balance, one with a $200 balance and both of them with a $5000 credit limit your total credit utilization will be 22%.

What does a good credit utilization ratio look like?

A popular rule of the thumb lists any rate below 30 percent as a very good credit utilization ratio but there is no particular credit utilization threshold that would help or cause injury to your score.

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Instead, just simply try to keep your balance and utilization ratio as low as possible for the best chance of improving your score.

How are you going to lower your credit utilization ratio?

There are two ways you are to lower your credit utilization ratio: Reduce your balance or increase your available credit. Applying for a new credit card or a higher credit limit can give you more credit utilization breathing space and boost your credit score in the process.

If you are having trouble paying off your balance, a balance transfer credit card can not only help you maintain interest at bay long enough to settle your balance but can also lower your utilization ratio through more available credit.

Does requesting a lower credit limit affect my credit score badly?

When you lower the credit limit on your credit card it could hurt your credit scores if it raises your credit utilization rate. Your credit utilization rate measures how the amount of your available credit that is being used by you.

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Your credit limits compared with the balances on your revolving credit account (typically credit cards) is an important scoring factor, and a lower utilization rate can generally help you to improve your credit.

You may be able to offset the impact by using your credit card less often than you use it or by paying down a card’s balance before the end of its statement period

Conclusion

Credit Utilization just like your payment history has a great influence in the determination of your credit score by the two major scoring models, FICO score and Vantagescore. It is the second most influential factor that affects your credit score. The lower your credit utilization ratio, the higher the chances of improving your credit score and vice versa.

With that being said, you already know how credit utilization ratio is important for the improvement of your credit score.

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