Credit utilization refers to the percentage of your available credit that you currently use. It’s an important factor considered by credit scoring models when calculating your credit score. Typically, credit utilization is calculated separately for each credit account and for your overall credit portfolio.
To calculate the credit utilization ratio, you divide the total outstanding balances on your credit cards by the total limits on those cards. Then, multiply the result by 100 to get a percentage. For instance, if you have $2,000 in balances and a total limit of $10,000 across all your cards, your credit utilization ratio would be 20% (2,000 / 10,000 * 100 = 20%).
Credit scoring models like FICO and VantageScore take into consideration your credit utilization because it reflects how responsibly you handle your credit. A low ratio is generally viewed positively by creditors and scoring models as it indicates that you’re not overly reliant on credit and are managing your debts effectively. Consequently, maintaining a lower credit utilization can have a positive impact on your overall credit score.
Conversely, a high ratio suggests that you’re utilizing a significant portion of your available credit. This could indicate potential financial strain or higher risk associated with borrowing more than what is advisable. This could have a negative impact on your credit score since it suggests a higher chance of missing payments or defaulting on debts.
It is often advised to keep your credit utilization ratio below 30% to have a positive effect on your credit score. However, maintaining an even lower utilization rate, like below 10%, is even more beneficial for your score. When you keep your credit card balances relatively low compared to your credit limits, it shows responsible management of credit and can gradually enhance your credit score.
Remember that credit utilization is not static but changes monthly as your credit card balances and limits fluctuate. That’s why regularly monitoring and managing your credit utilization plays a crucial role in maintaining a healthy credit score. If you demonstrate the discipline to handle your credit responsibly, there’s a good chance that over time, you’ll see an improvement in your credit score.