We’ve briefly touched on credit utilization before and how it can impact your credit score. However, given that it can influence up to 30%(!) of your credit risk to lenders, we thought it was worth going into a little more depth as to how it works, how you can use it to your advantage, and ways to improve it. So, grab a seat, and let’s learn how credit utilization factors into your overall financial wellness!
What is credit utilization?
Simply put, credit utilization is how much credit you use out of the total amount of credit you’re offered. It’s calculated as a percentage and, thankfully, is an easy equation to work out:
Utilization = What you owe ÷ Your credit limit.
So, if you owe $3,000 and your credit limit is $10,000, then your utilization percentage is 30% (3,000 ÷ 10,000 = .3(multiplied by 100) or 30%). Not too difficult, right?
Why does credit utilization matter?
When lenders are deciding whether to approve credit for an individual it all comes down to risk. The more financially risky the individual, the less the chances they get approved for credit. Over time, lenders have come to rely on certain factors to help them determine risk and credit utilization is a big one. If your utilization percentage is high, lenders think you rely heavily on credit which makes you a riskier candidate to pay back what you owe. If your utilization percentage is low, you’re demonstrating to lenders that you don’t rely on credit as heavily and are therefore a more attractive candidate to approve.
What should your credit utilization be?
In short, as low as possible! A good rule of thumb is to aim for 30% or lower but the smaller that percentage is, the better it is for your overall credit score. Even if you pay off your credit card on time, maxing it out every month can still result in a high utilization percentage. So try and make purchases strategically in order to ensure you keep your utilization as low as you can.
Ok, so how do I improve my utilization?
Great question! The easiest thing, of course, is to just not place as much on your credit cards. Set a balance limit for each of your cards and hold yourself to it. The quicker you pay off your balances, the more wiggle room you have to play with. Additionally, you can also apply for more credit cards (we hear there’s a health & wellness credit card coming soon that’s pretty good 😎). While this may seem slightly counterintuitive, new credit cards will increase your credit limit which will help lower your utilization percentage.
Knowing how credit is built and scored will not only make you a more informed consumer but will also help ensure you get the most out of your own score. With some planning and strategic budgeting, you’ll be able to take full advantage of your good credit whenever you need it.