Credit utilization is one of the most important factors contributing to your credit score.
Your credit utilization ratio refers to how much available credit you have at a given time. Credit utilization is critical because it signals to lenders whether you can use credit responsibly and pay your debts. In fact, credit experts say that it can impact up to 30% of your overall credit score.
Many financial experts say that you should aim to use 30% or less of your credit, but this also depends on how much credit you have and how you use it. Creditors want to see that you can use credit responsibly, not just avoid using it altogether.
With this in mind, let’s dive into the ins and outs of credit utilization and total available credit.
How is my Credit Utilization Ratio Calculated?
Your credit limit and available credit are the two essential factors in calculating your credit utilization ratio.
A credit limit is the total amount of money you can borrow from a line of credit.
For example, let’s say you apply for a credit card and are granted a credit card limit of $3,000. The credit card company has agreed to let you carry a balance of up to $3,000 on the card. This limit includes any interest that accrues on your purchase balances.
Your available credit is the amount of your credit limit you aren’t using at any given time. If you make $500 worth of purchases on your $3,000 line of credit, you have $2,500 of available credit.
Once you know your total credit limits and available credit, calculating your credit utilization ratio is easy. Keep in mind that your credit utilization ratio accounts for all lines of credit in your name, not just a single line of credit.
To calculate your credit utilization ratio, divide your total balance (credit limit minus available credit) by your total credit limit and multiply by 100. If we stick with the example of the credit card above, this would be:
$500/$3,000 = 0.1667 * 100 = 16.67%
This means that the total credit utilization of the credit card is 16.67%
How Do Credit Bureaus Use Credit Utilization Rates?
Unfortunately, not every credit scoring model uses credit utilization ratios in the same way to calculate credit scores.
However, the three major credit bureaus – Experian, Equifax, and TransUnion – give similar advice regarding credit utilization.
Two major credit scoring models are used to determine credit scores:
The two have minor differences regarding how accounts are reported and calculated to determine credit utilization.
For example, your FICO score will not consider home equity lines of credit, HELOCs, in your credit utilization, but your VantageScore credit report will. Your FICO score might include a closed account with a remaining balance, while VantageScore will not.
Both credit scoring models treat active lines of credit and closed, paid-off accounts similarly. Closed and paid accounts will not factor into your overall credit score. Credit-scoring companies will consider the most recent credit limits and balances when calculating your overall credit score.
As a result, your score may rise or dip depending on your credit card balance or other account balances when the companies conduct a credit inquiry.
How Much Credit Should You Have?
There is no hard-and-fast rule for how much credit you should have. You want to have enough to cover larger expenses right away or an emergency expense, but not too much that you start to rack up credit card debt. Ultimately, the amount of credit you have will depend on your goals and needs.
While there is no rule saying how much credit you should have, there is some data that suggests the amount of available credit you should have. Credit bureaus have reported that, unsurprisingly, people with higher credit scores tend to have more available credit, and vice versa.
Here is how much available credit each credit bracket has on average:
|Available Credit %
|Poor Credit Score (300-579)
|Average Credit Score (580-669)
|Good Credit Score (670-739)
|Very Good Credit Score (740-799)
|Excellent Credit Score (800-850)
It is worth noting that those with excellent credit scores don’t necessarily spend less than other credit brackets.
Instead, it is likely that they have higher credit limits and have lower credit utilization rates as a result.
How Can You Increase Your Credit Limit?
If you’re looking to improve your credit utilization score, one of the easiest ways is to increase your overall credit limits. Here are two popular ways to increase your credit limit and drop your credit utilization rate.
1. Ask for an increase on existing cards
Many credit card issuers are willing to credit increases for existing cardholders. They typically make this a simple process; in most cases, you can request an increase online or through a mobile app.
Something to keep in mind before requesting a credit limit increase is that most issuers will conduct a hard credit check before approving the increase. This may cause your credit score to drop, so it’s important to be aware of it.
2 Open a new credit card
If you want to boost your credit limit by more than just a little, you can open up a new credit card. The credit limit on the new card will be added to your overall credit and boost your credit utilization score. You can also do a balance transfer if you want to take advantage of any cash-back rewards your new card offers.
Keep in mind that adding a new credit card will decrease your age of accounts score, which can also impact your credit score. That’s why it is wise only to open new credit cards when needed and wait at least six months in between applications.
Can Too Much Available Credit Hurt Your Credit Score?
There isn’t really such a thing as ‘too much credit.’ However, you may find that having access to too much credit is bad for your spending.
When a credit card company increases your limit or issues you a new credit card, they don’t expect you to use the entire balance. Instead, it would help if you only used as much credit as you can afford to pay back. If you see your credit card limit as a license to spend, then you may find that there is such a thing as too much available credit.
In terms of credit monitoring, credit bureaus typically like to see lots of available credit. However, they also want to know that you’re using at least some of your credit. You will notice above that people with excellent credit don’t abstain from using credit altogether. Instead, they use minimal amounts in relation to their overall limits. Using credit sparingly and responsibly is critical for boosting your credit score.
How to Use Credit Responsibly
People with excellent credit scores aren’t the ones who don’t use credit cards at all. They’re the ones who know how to have access to credit without going crazy.
If you want to learn how to earn good credit, here are some ways to use credit responsibly.
Pay down your balances in full every month
Payment history plays a massive role in calculating your credit score, so it’s essential to make sure you pay your credit card balance every month. Paying off your entire balance every month is a great habit to get into to make sure you aren’t relying on credit too much.
If you are already carrying a balance, the best thing you can do is pay it down as much as you can. This will help reduce your overall credit utilization and help you dig your way out of debt.
Ask for a credit limit increase
If you have proven to be a responsible cardholder, most credit card companies are willing to increase your credit limit. It’s important to see this credit limit increase as nothing more than a safety net. As long as you don’t spend too much, adding more credit to your account is a simple and effective way to improve your credit score.
Don’t close old credit cards
Your credit score takes the overall age of your credit accounts into consideration. Just like low credit utilization shows lenders that you’re a responsible borrower, having a higher average age of accounts shows that you can maintain lines of credit for an extended period. As long as your old credit cards don’t have annual fees, it would be best if you kept them open.
One of the first steps to improve your personal finances is improving your credit history. One of the best ways to do this is to start using your credit card accounts more responsibly.
Having more available credit is never a bad thing. When lenders perform a hard inquiry on your account, it helps to show that you are able to maintain revolving credit without needing to hide your card away in a drawer. If you maintain low credit utilization, you will begin to see your credit improve over time and receive better interest rates on personal loans.