What is Credit Utilization? Tips to Use it to Your Advantage
If you're wondering, "What is credit utilization?" you're not alone. Your credit utilization rate isn't discussed as often, but it's an important part of your overall credit score. It factors in how much credit you are currently using to how much you have available.
For lenders, your credit utilization rate indicates how much outstanding debt you have and if you have room to take on additional debt (or if you're stretched to your credit limit). Here's how to understand credit utilization and how to use it to your financial advantage.
What Is Credit Utilization?
Credit utilization, more commonly referred to as credit utilization rate, is a calculation of how much revolving credit you're using divided by the total amount of revolving credit you have available. Revolving credit is credit that you can reuse again and again with no payoff date, such as credit cards.
A high credit utilization rate typically means that you're using the majority of the credit you have available. Say, for example, that you have two credit cards with a combined limit of $10,000. If you carry a balance on these cards totaling $8,000, your credit utilization rate is $8,000 divided by $10,000, or 80 percent. An 80 percent utilization rate would signal to lenders that you're using a majority of your available credit and that you might not have the financial capability to take on new debt.
How Can I Lower My Credit Utilization Rate?
You can take a variety of actions to potentially lower your credit utilization rate. Here are a few steps you can take:
- Keep a Low Revolving Balance Each Month: Keeping low balances can also lower your credit utilization rate by reducing your outstanding debt.
- Keep Credit Cards Open at a Zero Balance: Keeping some cards open, even if you don't use them regularly, can boost your available credit, thus lowering your utilization rate. Check to see which cards in your wallet have annual fees. While no annual fee is preferable, you'll want to pay off any fees that are charged during the billing cycle.
- Apply for a Credit Increase: If you have a timely payment history and good credit, applying for a credit line increase can lower your credit utilization rate by increasing the amount of credit you have available.
If you want to close a credit card, first consider your credit utilization. If the card makes up a large portion of your available credit, closing it could negatively impact your credit utilization rate by lowering your overall available credit.
Remember to keep an eye on how much of your credit you're using at any one time. Lenders like to see responsible credit management, and maintaining a low credit utilization rate shows them that you can keep your finances under control.
How Can My Credit Utilization Rate Affect My Credit Score?
According to The Balance, your credit utilization rate can account for up to 25 percent of your overall credit score. A high utilization rate can lower your credit score. As you pay down revolving lines of credit, your credit score will likely increase.
If you're preparing to make a major purchase and you want to qualify for the best loan rates, you can plan ahead to bring down your credit utilization rate to 25 percent or less. A low ratio shows lenders that you're doing a responsible job of managing your credit obligations and that you represent a low credit risk.
