How does Credit Utilization Work?

People usually focus on their credit score, interest rate, or credit limit when using credit cards. One of the factors of a credit card that they forget to take into account is their credit utilization, which affects their credit score. As professionals at SoFi point out, “about 30% of your credit score is determined by your credit card utilization rate”.

Since it’s crucial to understand how credit utilization works, we’ll cover what credit utilization is, how to calculate your ratio and what steps to take to lower your credit utilization.

What Is Credit Utilization?

Your credit card utilization rate is the relative difference between the limits on your credit cards and what you owe on them. For example, if you have a credit limit of $1,500 and owe $800, your utilization percentage is 53.33%. However, if you have three cards, each with a $1,500 credit limit, and you don’t use the other two but owe the same $800 balance on card 1, your overall credit utilization drops to 17.78%. Two credit scoring agencies, Vantage and FICO, use your credit utilization as a factor when determining your credit score; high utilization negatively impacts your score.

What Is A Good Utilization Ratio?

When you have a higher utilization ratio and often max out your credit limit, you’re at risk for credit companies to consider you a possible credit risk. While there’s no magic number, the general rule is to keep your credit utilization below 30%, as anything higher can decrease your credit score even if you pay your credit cards on time or before the due date. If you do find that you exceed the 30% utilization ratio after a purchase, it’s best to make a payment that will bring it below that level before your card’s due date, which is when your card reports your utilization to the credit bureaus.

How Is Credit Utilization Calculated?

Credit utilization calculations are a two-step process. Not only does the utilization count for the cards themselves, but also for the total balance on all the cards you have divided by the sum of the credit limits. Let’s say you had four credit cards:

  • Card one has a $5,000 limit with a $0 balance
  • Card two has a $10,000 limit with a $5,000 balance
  • Card three has a $2,500 limit with a $250 balance
  • Card four has a $7,000 limit with a $1,500 balance

Card one would have a 0% utilization, card two would have 50%, card three has 10%, and card four has 21% utilization. However, the overall credit utilization that you would have is 27.5% for all four cards, which is under the 30% recommended utilization.

Steps to Lower Your Utilization

According to the FICO scoring model, your payment history makes up 35% of your credit score, while your credit utilization makes up another 30%. One way to reduce your utilization ratio is to ask for a higher credit limit. If that fails, you can apply for another card, but only if you can afford to pay back the money you spend on it. The best way to lower your utilization is to pay down your debt by paying more than your minimum payment.

Keeping track of your credit card utilization rate can be tricky, but not when you have SOFI on your side. If you’re ready for a different kind of credit card, sign up today! With a credit card from SOFI, you don’t have to worry about an annual fee eating into your savings, and you receive an incentive to make payments on time.

Leave a Reply