Credit Utilization: What Is It and How Do You Calculate It?

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Your credit score reflects your financial status and impacts loan approvals, apartment rentals, and job opportunities. One crucial factor in calculating your credit score is the ‘credit utilization ratio’. Let’s explore what this means and why it matters.

The credit utilization ratio compares the credit you’ve used to the total credit limit available, represented as a percentage. For example, if you have three credit cards with a $10,000 limit each and balances of $6,000, $4,500, and $3,000 respectively, your credit utilization is 60%. High utilization can harm your credit score, as it suggests reliance on available credit. This ratio carries significant weight, accounting for almost 30% of your score.

Credit utilization is relevant to revolving credit, such as credit cards and open credit lines. It does not apply to installment loans. Calculating your utilization rate is simple: compile a list of your cards and credit lines, sum up your total card debt, determine your total credit limit, divide the debt by the limit, and multiply by 100.

Most experts recommend maintaining a utilization rate below 30% to show responsible credit usage. Consumers with top-tier credit scores had utilization below 10%. Note that while overall utilization matters, high utilization on any one card can be a red flag.

To ensure a healthy credit score, keep your per-card utilization within recommended limits.

Your credit score, indicating your financial health, is calculated based on important factors. Let’s examine these factors according to the widely used FICO scoring model:

  1. Payment History (35%): Demonstrates your reliability as a borrower. Late or missed payments raise concerns for lenders, indicating potential repayment difficulties.
  2. Credit Utilization or Amounts Owed (30%): Crucial in determining your credit score. High credit utilization suggests excessive debt, making lenders cautious.
  3. Length of Credit History (15%): Considers the age and activity of your credit accounts, including the time since last use.
  4. Variety in Credit (10%): Reflects diversity in your credit and lending accounts.
  5. New Credit (10%): Opening multiple accounts within a short period raises red flags for lenders, suggesting financial challenges.

To lower your credit utilization rate, consider the following strategies:

  1. Pay off more debt: Make extra credit card payments each billing cycle to gradually reduce your credit utilization ratio. Credit reporting agencies like Equifax, TransUnion, and Experian report credit card activity monthly.
  2. Distribute charges across multiple cards: If you mainly use one credit card, its high utilization ratio may not reflect your overall utilization. Distribute spending across several cards to ensure none exceeds a 30% utilization rate.
  3. Request a credit limit increase: If you have a good credit score, ask your credit card issuer for a higher limit. While you may not use the increased limit, it can help reduce your credit utilization ratio. Keep in mind that requesting new credit or balance transfer cards results in a hard credit inquiry, temporarily lowering your credit score.

Strategies for Financial Stability

To ensure financial stability, there are several strategies you can employ. One important aspect is understanding how to effectively use credit. By managing your credit wisely, you can avoid overspending and secure loans with lower interest rates in the future.

If you’re looking for an investment opportunity that provides both long-term growth and short-term liquidity, consider Foothold. Our mission is to make financial independence accessible by offering you to fractionally invest in vacation rentals. It’s important to note that the information shared in this article is generic and not tailored advice or specific recommendations. The viewpoints expressed may change without prior notice. For more information, please refer to Foothold’s disclaimers.

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