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How Does Credit Utilization Affect Your Credit Score?

January 25, 2024

Your credit score is calculated based on a variety of factors, dependent on the scoring system used. This is not just a random number but a precise calculation based on your financial behavior. One of the key factors in both major scoring systems is credit utilization.

In this guide, we'll unravel the mysteries behind credit utilization and its direct impact on your credit score.

What is a Credit Utilization Ratio?

A credit utilization ratio is a percentage that represents the amount of your available credit that you are currently using. It’s a critical factor in determining your credit score. To calculate your credit utilization ratio, first divide your credit card balances by your credit limits. Then, multiply by 100 to get the percentage.

For example, if you have a credit card with a $1,000 limit and you have a balance of $300, your credit utilization ratio would be (300 / 1,000) * 100 = 30%. This means you are utilizing 30% of your available credit.

Creditors and credit scoring models use this ratio to assess how responsibly you manage your credit. A lower credit utilization ratio is considered better for your credit score, as it suggests that you are not overly reliant on credit and can manage your finances more effectively.

Individual Account Utilization vs. Total Credit Utilization

Individual account utilization refers to the percentage of credit used on a single loan or line of credit. Total credit utilization is the average utilization on all of your accounts combined.

It's often recommended to keep your credit utilization below 30%. According to Experian™, total utilization and the account with the highest utilization matter for your credit score_[1]. So, this advice applies to individual accounts and your total utilization.

In a nutshell, keep all accounts under 30% for a happy credit score.

How Credit Utilization Affects Your Credit Score

Developed by the Fair Isaac Corporation, the FICO® score is one of the most widely used credit scores in the United States. In fact, it's the scoring system used by 90% of banks_[2]. Your FICO® score is a three-digit number that ranges from 300 to 850, based on information from your credit reports_[3].

VantageScore® is another credit scoring model. It was created collaboratively by the three major credit bureaus: Equifax™, Experian®, and TransUnion™. It also provides a three-digit score, ranging from 300 to 850, and aims to provide a consistent score across all three credit bureaus. Your VantageScore™ is the one you’re most likely to see in credit monitoring platforms like CreditKarma™.

Both FICO® and VantageScore® systems recommend you maintain a credit utilization below 30%. So, there’s a universal belief that lower credit card usage reflects responsible financial management. Regardless of the scoring model, keeping your credit utilization in check is a key factor in a healthy credit score.

Here's a breakdown of how different credit utilization levels might affect your score:

Excellent (0-10%): You're in the green zone. Lenders typically view you as a low-risk borrower.
Good (11-30%): This range is generally acceptable, but keeping it lower can boost your score.
Fair (31-50%): Your credit score takes a hit. Lenders may start perceiving you as a higher risk.
High (51-70%): Be cautious. This level of credit utilization can impact your score negatively.
Very High (71% and above): Danger zone. This will usually seriously harm your credit score.

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How Much Does Credit Utilization Affect Your Credit Score?

Ideally, you want to keep your credit card and loan balances low, but that’s not all. There are other factors that affect your credit scores. And, credit utilization makes up a significant percentage of your FICO® and VantageScore® scores.

The most important factor for both types of scoring is payment history. So, above all, you should pay your accounts on time as agreed. Still, utilization is very important within both scoring systems.

“Amounts owed” make up 30% of your FICO® score.
“Percentage of credit used” makes up 20% of your VantageScore®.

Unlike other aspects of your credit score, credit utilization can change your score immediately upon change. For example, a hard credit inquiry (an application for credit) can make your score drop a few points[4]. Then, it stays on your report for two years. And a hard inquiry can impact your score for up to a year.

On the other hand, if you pay your debt below 30%, the scoring impact takes effect as soon as the account is reported. This works both ways. So, if you use a large portion of your credit and do not pay it off before the reporting cycle, it can have an instant negative impact on your score.

In sum, your credit utilization has a significant, immediate impact on your credit score. Keep utilization low for an optimized score.

Strategies to Guide & Manage Credit Utilization

Here are some practical strategies to help you manage credit utilization effectively:

Regularly check your credit report for inaccuracies and negative items.
Address negative or incorrect items on your credit report right away.
When possible, pay off credit card balances immediately to avoid interest charges.
Aim to keep your credit card balances within the recommended utilization range.
Pay down your high-interest debts first to save the most money.
Consider asking your credit card issuers for a credit limit increase. If successful, this can instantly lower your credit utilization.
Avoid unnecessary credit card debt. Only use credit when it makes financial sense.

Again and more importantly, always pay your accounts on time as agreed. Credit utilization is major, but payment history has an even greater impact on your score.

If you forgot to pay bills, used too much credit, or saw bad stuff on your credit report, don't worry. You can make your credit better.

Impact on Credit Scores

Credit utilization is a star player in the credit score game. Second to payment history, utilization can have an immediate good or bad impact on your score. When you understand how it works and implement smart strategies to manage it, you can boost your credit score.

In sum, keep your credit utilization below 30% and always pay your accounts on time as agreed.

At Centier Bank, we're here to guide you on your journey to financial success. Let's work together to unlock your credit score potential!

If you're in Indiana, drop by one of our branches or book an appointment today.

Sources:

[1] https://www.experian.com/blogs/ask-experian/credit-education/score-basics/credit-utilization-rate/

[2] https://www.ficoscore.com/about

[3] https://www.annualcreditreport.com/index.action