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When it comes to credit reports and credit scores, the term “credit utilization” is a popular yet mysterious term that is thrown around frequently. If you have spent much time reading about credit, you probably have at least a vague concept of what credit utilization is.

What is Credit Utilization

In simple terms, credit utilization is a term used to describe the percentage of open credit a person is using. Generally, credit utilization is mentioned as a percentage, and is calculated by dividing the amount of money you owe by the total amount of open credit you have. For example, if you have $10,000 in open credit on one card and your balance is $3,500, your utilization is 35%.

Credit utilization figures into the calculation of your credit score, but it is done on both a per credit card basis – sometimes referred to as per card utilization – and on a comprehensive level, sometimes referred to as aggregate utilization.

Aggregate utilization is calculated by taking all the debt you owe on all of the credit lines you have, and dividing it by all the total amount of credit you have available.

Let’s say that you have three credit cards. On Credit Card A you owe $5,000 on a $10,000 credit limit; on Credit Card B you owe $2,000 on a $5,000 credit limit; and on Credit Card C you owe $1,000 on a $5,000 credit limit.

If that’s the case, your aggregate utilization would be figured like this:

(credit owed $5,000 + $2,000 + $1,000 = $8,000) divided by (your total credit limits of $10,000 + $5,000 + $5,000 = $20,000) = $8,000 / $20,000 = 40%

How Credit Utilization Affects Your Credit Score

The three major credit reporting agencies – TransUnion, Experian and Equifax – make use of the FICO credit scoring model. FICO uses five credit category factors to calculate your credit score:

  • Payment History – 35%
  • Amounts Owed – 30%
  • Length of Credit History – 15%
  • New Credit – 10%
  • Types of Credit in Use – 10%

Since credit utilization is considered under the “amounts owed” section of your FICO score, you can see how important it really is. Even if your credit is perfect in all other ways, having a high utilization can bring your score down considerably due to the simple fact that it makes up such a large percentage of your score.

With the FICO scoring model, “amounts owed” considers three things:

  1. The number of accounts with balances – a higher number indicates higher risk
  2. Credit utilization on revolving accounts – the higher the percentage of utilization on your lines, the greater the risk that you will max out your credit and not be able to make the payments
  3. Amount owed on installment loans – or how much is owed compared to the original loan balances

Many people focus on #2 only, and incorrectly assume that it represents 30% of their FICO calculation all by itself. But it is only part of the total “amounts owed” category. A high balance on an installment loan – say, $9,000 owed on a loan with an original balance of $10,000 – will also have a negative impact.

How Much Credit Utilization is Too Much?

A credit utilization ratio of up to 30% is considered ideal. With a 30 percent utilization rate, you’re carrying some debt but it isn’t considered problematic. When your ratio exceeds the 80% to 85% range, on the other hand, credit reporting agencies and lenders will consider you maxed-out.

Related: Tom Quinn of FICO says 10% is ideal

In theory at least, your credit score may drop as your credit utilization ratio rises. But the prospect of being maxed out is where per card utilization becomes important as your balances grow. A single maxed out card will cause your credit score to fall, but generally not as much as most people think. Multiple maxed out cards, on the other hand, will result in a drop that is much more significant.

The Effects of High Credit Utilization May Vary

Although people would like to know exactly how much their credit score will drop based on a different levels of utilization, it’s hard to say. The truth is, there are too many factors to consider to come up with any hard-and-fast rule.

How much credit utilization will affect anyone’s credit score will depend upon a number of factors, and even then, the impact can vary. For example, the effect of one maxed-out card may be lower for someone with 10 credit cards, compared to someone with only three.

The Takeaway from Credit Utilization

It’s not possible to know exactly how high credit utilization will affect your credit score. Instead of stressing over exact percentages, you would probably be better off using common sense when it comes to your credit. Know that a higher ratio will hurt your score, and a lower one will improve it. Then act accordingly.

Also understand that credit utilization is only part of the makeup of your credit score. That means that, in addition to keeping your credit card balances low, you should also limit the number of accounts with balances and use common sense when it comes to opening new credit.

Related: Check out your credit score for free

Meanwhile, you should also do your best to keep old credit lines open – even after you pay them off. The open lines contribute to your available credit and will have the effect of lowering your credit utilization ratio. Since closing them lowers your available credit, it could raise your utilization by default.

And since you know it’s impossible to predict your score based on any one factor, do your best to avoid checking your score every day or stressing out over the little ups and downs. No matter what, the best way to improve your credit score is to improve your credit profile across the board.

Do you know what your credit utilization ratio is? Do you think it is helping or hurting your credit scores? Have you noticed any correlations?

Author Bio

Total Articles: 134
Since 2009, Kevin Mercadante has been sharing his journey from a washed-up mortgage loan officer emerging from the Financial Meltdown as a contract/self-employed “slash worker” – accountant/blogger/freelance blog writer – on OutofYourRut.com. He offers career strategies, from dealing with under-employment to transitioning into self-employment, and provides “Alt-retirement strategies” for the vast majority who won’t retire to the beach as millionaires.

Article comments

Money Beagle says:

You definitely don’t want to be using all of your credit as that is likely to decrease your credit score, and either make it more difficult to get any additional credit and/or make it come at a higher cost if you do in fact get approved.

Rob says:

After reading this article I am curios, I was working very hard at repairing my credit. doing everything right , I was trying to use a card with points as a way to max out my return on my investment. I put Christmas on the card and will pay the entire bill next month. before I made the payment it was reported I maxed the card out and whamo a 19 point drop! any suggestions on how to avoid this? I had the cash but was simply trying to earn points for using the card.

Rob Berger says:

I’m not sure it can be avoided if you max the card out. But I suspect once you pay it off you see a positive jump in your score.

Brian Denney says:

Thanks for the info. I have excellent perfect credit except for high utilization. It’s really dropped my score. I have about 100k equity in my home really want to refi. If I got my 5 cards under 85% do think it would raise score much? Get me out if the “maxed out” zone? My credit was always 700+, now 609 🙁

Stephanie Colestock says:

The lower you can get that utilization, the higher your score will jump. If you’re looking at a refi, you don’t want to be opening any new accounts right now (new cards = additional credit = lowered utilization). However, it would be worth calling your 5 cards and requesting an increase in your credit limit. Depending on your history with them and how high your existing credit lines are, they may very well be willing to bump you up a bit. If they do, your utilization will drop without any extra work on your end.

From there, you’ll want to direct as much cash as you can toward paying those balances down. The closer you can get to 30-40% utilization, the better refi rate you’re going to snag. And that has the potential to save you thousands (if not tens of thousands) in the long run.

Best of luck!