If you’ve done some research into how your credit score is calculated, you’ve probably come across the term ‘credit utilization’. Credit utilization is one of your credit scores’ major factors. Credit reporting bureaus use your credit utilization to determine up to 30% of your credit score – it’s a significant amount of influence.
But like many financial concepts, credit utilization can be a bit hard to understand. This guide is intended to help anyone who would like more information about credit utilization and why it’s important. It will explain how it is calculated, why lenders use it, and different ways you can use your credit utilization to your advantage. Make sure to take in all the content from this article – this is a topic you can’t afford to misunderstand.
What is Credit Utilization?
Credit utilization is the amount of your credit limit that is currently in use. When you apply for certain types of finance, you will be extended a credit limit that determines the amount of money you can spend. The amount that you’re utilizing is the amount that you have borrowed from the lender.
Why Lenders Care
Lenders care because credit utilization tends to be an easy way to view what type of borrower someone is. Someone who uses more of their limit is typically a riskier borrower. If you’re someone who struggles to manage their finances, you may end up with a lot of credit card debt.
But it’s not just about your borrowing characteristics. The amount of debt you have also influences your ability to pay off other debts. If you have a large amount of credit card debt, a new credit card company isn’t very likely to offer you another credit card. Lenders don’t want to lend to individuals who will already struggle to pay off their current debt levels.
How Is It Calculated?
Credit utilization is calculated quite simply. Credit reporting bodies will add up all your credit balances and then divide them by your credit limits. Your utilization is simply a percentage of the limits that are currently in use. Your total limits are referred to as ‘available credit.’ If you have extremely high limits, you can afford to have a pretty hefty balance on your credit accounts. The dollar amount is irrelevant – lenders are looking at percentages.
What Kind of Debts Enter Credit Utilization?
So, what kind of debts are used to calculate credit utilization. The only debts that enter into credit utilization are those that are based off revolving credit. We will explore the two types of revolving credit often found in an individual’s credit utilization.
The most common lending product included in credit utilization is a credit card. Credit cards are the most popular form of revolving credit. You are extended a limit by your lender, and can use as much of that money as you want – as long as you pay your monthly payment. At the end of the statement period, your lender will calculate your balance and send it the credit reporting bodies.
Lines of Credit
The other common form of revolving credit is a line of credit. Many people prefer these to credit cards as they allow you access to cash at no additional cost – they also tend to have lower interest rates. As with credit cards, your line of credit lender will send your statement balance to credit reporting bodies at the end of each statement period. This will be factored into your credit utilization.
What Kind of Debts Don’t Apply to My Utilization?
It’s also important to consider which types of debt don’t impact your credit utilization. We’ll explore these loan types in more detail below.
Term loans are extremely popular in the United States. They’re used to finance homes, cars, and other purchases. Term loans will not be factored into your credit utilization. But your on-time payments will be included in your credit score – make sure to stay on top of your term loans.
Other loans, such as payday loans or title loans, won’t count into your credit utilization either. Again, ensuring you don’t default on these loans and making all your payments on time is vital to ensuring your credit score goes unaffected.
Keep Your Utilization Low
If you want to make sure that your credit score is as healthy as possible, you should always aim to keep your utilization low. The best way to do this is to pay as much of your credit balance off before your statement date comes. If you wait for your statement to close, you will record the balance that is left on the card. Even if you pay the entire balance off after your statement, your credit utilization will still be high. This is why you should always pay as much debt off as possible before the end of your billing period.
Because these statements are typically updated every month, this can be one of the quickest ways to have a profound impact on your credit score. If you feel that your credit score is too low – have a look at your report and see what your credit utilization is. You should always try and pay down your debt before you apply for any new financing – this will greatly improve your chances of approval.
As you can tell, credit utilization is an extremely important topic — you should aim to use your credit utilization to improve your credit score as much as possible. But remember, credit utilization is just one component in your credit score – there are a range of other contributing factors.
Those with the best credit scores are those who consider every component of their score. Take time to understand credit scores and how they can impact your future. Make sure you know how to build credit – it’s one of the most important investments you can make in yourself. If you have other questions about credit scores and how they’re calculated, make sure to check out some of the other content on our site and learn more about consolidation loans.
Financial Advisor, DCL
Dan is one of the top financial experts when it comes to debt consolidation. With more than 20 years of experience helping people tackle debt, he has a unique insight when it comes to solving debt-related problems.
Dan got his start when he went to work for a bank after getting his Business Degree. He worked his way up and became a loan officer. This position gave him unique insights into the ways that financial products work and how people can utilize different financial products to improve their lives. He’s seen hundreds of success stories and just as many failures – so he knows what steps are most likely to help his readers.
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