What Is Credit Utilization?
Credit utilization refers to the difference between what a borrower owes on their credit cards relative to the cards’ credit limits.
Credit utilization measures how much available credit a borrower uses at any given time. It is among the components credit bureaus often use when calculating a borrower’s credit score. They calculate the credit utilization ratio by dividing the total credit balance by the full card limits. Generally, a lower credit utilization ratio improves borrowers’ credit scores and increases their chances of getting a loan.
Most lenders use a borrower’s credit utilization ratio to determine how much risk granting them a loan poses. If a borrower has a high credit utilization ratio, they use all or most of their available credit limit regularly. Lenders assume that such borrowers pose more risk, and they may have trouble paying back a loan. On the other hand, if a borrower has a low credit utilization ratio, they regularly use little or zero available credit limits. Lenders assume that such borrowers pose a lower risk and most likely would not have trouble paying back a loan.
Two credit scoring agencies, FICO and Vantage, list credit utilization as the second significant factor they consider when determining a credit score. Maintaining a low credit utilization ratio is essential as it signals to lenders that you know to use credit without depending heavily on it. Most experts recommend that you maintain a credit utilization ratio of not more than 30%. Anything higher may signal to lenders that you are spending beyond your means and may have trouble paying a new loan.
Some ways to maintain a lower credit utilization ratio include but are not limited to:
- Paying down your debt
- Consolidating multiple credit card balances into one with a lower interest rate
- Asking your credit card issuer to increase your credit limit
Credit Utilization Example
Margret has a credit card which she uses to cover her expenses when she exhausts her salary before the end of the month. Margret’s credit card has a limit of $8,000, and she has used $2,000. Her credit utilization ratio is 25% of the available credit limit.« Back to Glossary Index