Credit utilization is a key factor in determining your credit score. It refers to the amount of available credit you are using at any given time, expressed as a percentage of your credit limit. The higher your credit utilization, the lower your credit score is likely to be.
Credit reporting agencies, such as Equifax, Experian, and TransUnion, use credit utilization as a way to assess your creditworthiness. They calculate your credit utilization ratio by dividing your outstanding credit balance by your credit limit.
For example, if you have a credit card with a credit limit of $10,000 and you have a balance of $2,000, your credit utilization ratio is 20%. Generally, a credit utilization ratio of 30% or lower is considered good, while a ratio above 30% is viewed as a red flag.
Here are some ways credit utilization can impact your credit score:
High credit utilization can lower your credit score
Credit utilization makes up 30% of your FICO credit score, which is the most commonly used credit scoring model in the United States. A high credit utilization ratio suggests that you may be overextended financially, which can make you appear riskier to lenders. This can lower your credit score and make it more difficult to obtain credit in the future.
Low credit utilization can help improve your credit score.
If you keep your credit utilization ratio low, it can have a positive impact on your credit score. It shows that you are managing your credit responsibly and not overextending yourself financially. This can help increase your credit score and make it easier to obtain credit in the future.
Fluctuating credit utilization can affect your credit score.
Credit utilization is calculated based on your credit card balances at a particular point in time. This means that your credit utilization ratio can change from month to month, depending on how much credit you are using. If you have a high credit utilization ratio one month and a low credit utilization ratio the next, this can cause fluctuations in your credit score.
Closing credit accounts can affect your credit utilization and credit score.
Closing a credit account can have an impact on your credit utilization ratio, as it reduces your total available credit. For example, if you have two credit cards with a total credit limit of $10,000, and you close one of the accounts, your total available credit will be reduced to $5,000. This can increase your credit utilization ratio and lower your credit score.
Opening new credit accounts can also affect your credit utilization and credit score.
Opening new credit accounts can increase your available credit, which can lower your credit utilization ratio and improve your credit score. However, it's important to note that opening too many new credit accounts within a short period of time can also have a negative impact on your credit score, as it can make you appear riskier to lenders.
In summary, credit utilization is a key factor in determining your credit score. A high credit utilization ratio can lower your credit score, while a low credit utilization ratio can help improve it. Fluctuations in your credit utilization ratio, as well as opening and closing credit accounts, can also impact your credit score. It's important to manage your credit utilization responsibly to maintain a good credit score and increase your chances of obtaining credit in the future.