What is credit card utilization

By Izzy M
Modified on May 2, 2023
what is credit card utilization

Getting and maintaining a good credit score takes effort. Different factors, such as your credit utilization, can positively or negatively affect your credit score. It’s important to increase your financial literacy because you can learn how to manipulate credit scores. This article teaches how credit bureaus calculate a credit score and what credit card utilization is.

What Is Credit Utilization and How Does It Affect Credit? 

Your credit score is a numerical reflection of your creditworthiness. The FICO score model is one of many credit scoring models used to calculate credit scores. A borrower’s FICO score depends on the calculation of five financial categories. 

  • Payment History (35%)
  • Credit Utilization (30%)
  • Length of Credit History (15%)
  • New Credit Inquiries (10%)
  • Credit Mix (10%)

Credit utilization, or credit utilization ratio, is the amount of debt you have compared to your total credit limit. Your credit utilization ratio is one of the most critical factors for credit scores because it accounts for 30% of your credit calculation. 

You may receive a higher Credit limit from your credit card issuer if you have a good credit score or payment history. You may be inclined to use your generous credit limit to make high-cost purchases but be careful. Your credit score can decrease if you max out your credit card account. 

Lenders view borrowers with excessive debt as financial risks. High credit card balances can make it harder for you to qualify for new loans or credit lines. Although it’s not bad to have multiple credit cards, using most of your available credit can harm your credit score. Paying more than the minimum can help you quickly pay down your credit card balance. 

What Is a Good Credit Utilization Ratio?

According to the most commonly used credit scoring model, the FICO credit score, borrowers should keep their total credit utilization ratio below 30%. Using more than 30% of your available credit limits can make it hard for you to build credit and qualify for financial products. 

Suppose you have two credit cards—one with a $2,000 credit limit and the second with $4,000. In that case, your total revolving credit is $6,000. Keep your credit card usage below $1,800 to maintain a low credit utilization rate. 

How To Calculate Your Credit Utilization Rate

To calculate your credit utilization rate, you need to know your total credit card debt and total credit card limits. If you have multiple credit cards, add up each card’s balance and credit limit. Divide your debt amount by your available credit, then multiply the answer by 100 to determine your percentage. If you prefer to avoid doing the calculation, you can use a credit utilization calculator online. 

Suppose your total credit card debt is $3,000 and your credit limit is $6,500. When you divide these figures, you get 0.46. Multiply 0.46 by 100 to get your total credit utilization rate, which is 46%. This percentage is much higher than the recommended rate set by credit bureaus. A high credit utilization rate can negatively affect your credit score and limit your financial opportunities. 

Will a Credit Limit Increase Improve My Credit Utilization Ratio?

Your credit utilization ratio depends on your open and closed accounts, total debt, and credit limits. If your credit utilization ratio is too high, you can try increasing your available credit limit. A higher credit limit can help you get a low credit utilization ratio, improving your credit score!

If you successfully manage your credit card account, your credit card issuer may reward you by increasing your credit limit. The increase can be substantial if you consistently make credit card payments on time and have a good credit score. But you may still get more money to spend with a few late payments if your income has increased or your credit score is good. 

Suppose any of the following situations apply to you. In that case, you may not get approval for a credit increase at this moment.  

  • You have recently applied for a new loan or credit card.
  • You got a new job.
  • Your credit score is low.
  • You have a lot of late payments.

You can try increasing your credit line by calling customer service. Let an agent know you’re interested in increasing your credit line. If you do not get approval, don’t worry. There are alternative ways to get a good credit utilization ratio, such as paying down your existing credit card debt.  

How to Quickly Pay Off Debt To Improve Credit Utilization Ratio?

Having debt is not always bad, as there is good and bad debt. Good debt has a long-lasting positive impact on your finances. A mortgage loan is a good debt because you are working towards owning real estate. However, credit card debt is bad debt because borrowers lose more than they gain. 

If you want to improve your credit utilization ratio, the best method is to pay down your credit card balances. If you have a lot of credit card debt, it’s easy to get overwhelmed. But you can quickly become debt free by increasing your income, paying more than the minimum, and decreasing your expenses!

Increase Your Income

If you want to pay off your debt quickly, increasing your income is the best way. You can speed up the repayment process when you have more money to spend. Consider how much time you want to invest in a side hustle and what tasks you are capable of doing. You can sell your unused items online or through a yard sale. Use your vehicle to deliver groceries or takeout orders. Or sign up for apps that give you money instantly! The choice is yours to make.

Pay More Than the Minimum

Many credit card borrowers pay the minimum each month due to the low cost of payments. However, you will end up paying more interest fees. Most creditors offer borrowers the ability to pay the complete billing statement, the minimum, or the minimum plus an additional amount. 

Paying more than the minimum can help you pay down your credit card debt faster. Suppose your minimum payment is always $35, but you can afford an additional $40 monthly. In that case, you can significantly shorten your repayment schedule with $75 monthly payments! 

Decrease Your Expenses

Taking on a side hustle can be stressful if you already work a nine to five job. An easier way to increase your income is to decrease your monthly expenses. This way, you have more money available at the end of the month. Start by axing any unnecessary bills you can live without, such as video and audio streaming services. You can also start lowering your utility bills by making minor adjustments to your life. Try taking shorter showers, switching to energy-efficient light bulbs, and adjusting your thermostat when you’re away from home. 

The Bottom Line

If you want to build good credit, it’s essential to learn about credit utilization. Credit utilization is one of the most critical factors for credit score calculation. Maintaining a low credit utilization ratio can help you manage your debt and obtain a higher credit score!

An excellent credit score can help you qualify for better financial opportunities, such as fast cash loans with low rates. Good credit can also help you obtain more housing options and better rates on insurance. Now that you know what credit utilization is, you can start working on paying down your credit card balances to get financial freedom! 

What is a credit utilization rate and how to calculate yours

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