Credit Cards and Credit Utilization

Part of your credit score – 30% to be precise – is based on how much of your credit you’re using. This ratio of available credit to credit limit is called your credit utilization. Credit utilization not only depends on how you use your credit cards, but also how you pay your credit card balances, too. Understanding how credit utilization works can ensure you use your credit cards in a way that will boost your credit score.

Two Types of Credit Utilization

Several different credit utilization ratios go into calculating your credit score. First, the credit score considers the credit utilization of each of your credit cards. If your credit card balance is $300 and your credit limit is $1,000, then your credit utilization for that credit card is 30%.

Then, the credit score considers the total credit utilization of all your credit cards. If all your balances added together total $25,000 and all your credit limits are $50,000, then your total credit utilization ratio is 50%.

Which Credit Limits Are Best?

Lower credit utilization ratios are better for your credit score. This is because you’re a less risky borrower when you’re not using a large amount of your available credit. You should aim to keep your credit utilization for each credit card and your total credit utilization below 30%.

As your credit utilization gets higher than 30%, either for a single credit card or your total credit utilization, your credit score can drop because of the higher credit card balances.

Opening and Closing Credit Card Accounts

Opening and closing credit cards can both affect your credit utilization in a good way and a bad way, respectively. When you apply for a new credit card and you’re approved, you add a credit card with a utilization of 0% (assuming you don’t make a purchase as soon as you open your account). Your total credit utilization will also go down because you’ve added additional credit to your credit limit.

On the other hand, closing a credit card has a negative effect on your credit utilization, especially if the credit card has a credit card balance. Because there’s no available credit on that credit card, the credit utilization spikes to 100%. In addition, your total credit utilization goes up since you’ve lost some of your credit limit.

Credit Utilization and Your Credit Score

The good thing about credit utilization and how it influences your credit score is that it changes as your credit card balances change. Unlike other delinquent information, which stays on your credit report for seven years, credit utilization generally responds to your current credit card balance. If you’re losing credit card points because your credit utilization is too high all you have to do is pay your credit card balance down and you’ll notice your credit score going up. The change might not happen immediately because credit card issuers don’t report daily changes, but if you keep your credit card balances low you should notice an increase in your credit score.