Credit card utilization. A phrase that most people have never heard, and even less people care about. But guess what? Credit card utilization is what I’m here to write about! And guess what? You chose to be here. You chose to read this article because you care about your finances and you want to make sure that you can maximize your credit score.
Smart move!
Credit card utilization is one of the most important aspects of our credit files. It represents about 30% of your total credit score. It’s super important to keep it as low as possible. Credit card utilization is not a really hard concept to grasp but it is important to understand how it works.
So let’s get started.
Caveat Alert!
Although this article will be about maximizing your credit score by minimizing your credit card utilization rate, it is important to understand the dangers of how the credit “game” is played.
At the end of the day you want to have a great credit score (>700), or a 0 credit score. Although the argument for a 0 credit score is for another day, it is important to know that a 0 credit score is not a bad thing. A 0 credit score simply means that you have no debt nor any open accounts. In place of that, you have cash in the bank, savings, and investments.
However, for the majority of you reading this, you will have a credit score. And this article is for you!
Before you continue reading, just know that you should always pay off your credit cards EVERY month. Do not carry a balance. Credit cards carry extremely high interest rates and fees.
Tough love time: If you cannot pay off your credit cards each month, then you are not financially mature enough to have them.
Alright. Now that we have that out of the way, let’s figure out what a credit card utilization rate is and how you can improve yours and ultimately improve your credit score.
(1) Credit Limits
Most people are aware of what a credit limit is. But just in case, I’ll go over it. 🙂
Simply put, a credit limit is the maximum amount that you can spend on a credit card. If you sign up for a credit card and they offer you a $1,000 credit limit, that means that you can spend up to $1,000 on that card.
For the purposes of your credit card utilization rate, each card you have is added together to get your TOTAL credit limit. So for example, Nick has some credit cards that looks like this:
| Credit Card | Limit |
| Bank of America Credit Card | $3,000 |
| Chase Credit Card | $2,000 |
| Best Buy Credit Card | $5,000 |
| Total Credit Limit | $10,000 |
Remember, these are Nick’s credit LIMITS. Not the balances that he has on each of the cards.
Now that we know what Nick’s credit card limits are, let’s look at what his balances are and then do some quick (and easy) math to find his credit card utilization rate.
(2) Credit Card Debt
Let’s keep picking on Nick. You already know Nick’s credit limits. But we also need to know what his credit card balances are also. (A balance is the amount of money that you owe on your credit card.)
| Credit Card | Balance | Limit |
| Bank of America Credit Card | $500 | $3,000 |
| Chase Credit Card | $1,000 | $2,000 |
| Best Buy Credit Card | $1,000 | $5,000 |
| Total | $2,500 | $10,000 |
To find Nick’s credit card utilization rate, it is just this equation:
Total credit card balances / Total credit card limit = Credit card utilization rate
$2,500 / $10,000 = .25 = 25% credit card utilization rate
It’s as simple as that. Just add up all of your credit card balances and then divide that number by your total credit limit.
A couple of things to remember:
If you do not carry balances on your credit cards, your credit card utilization rate will be 0%. That is awesome!
Also, in order to help your credit score, you should always keep your credit card utilization rate below 30%. If it is higher than that, then it will actually hurt your credit score.
It doesn’t mean that you can’t spend more than 30% of your credit limits at any given time, it just means that when your billing cycle ends, you NEED to be below the 30% threshold.
(3) What happens when you pay off a credit card?
When you pay off a credit card that amount is subtracted from the total amount owed on all of your credit cards. So let’s look at Nick’s example if he were to pay off his Bank of America credit card.
| Credit Card | Balance | Limit |
| Bank of America Credit Card | $0 | $3,000 |
| Chase Credit Card | $1,000 | $2,000 |
| Best Buy Credit Card | $1,000 | $5,000 |
| Total | $2,000 | $10,000 |
This means that his total credit card utilization is 20% instead of 25% like it was before.
If he pays off the Chase credit card, his credit card utilization drops to 10%.
And as I’ve stated before, if he pays off all of his credit cards, his credit card utilization drops to 0%.
(4) What happens if you close a credit card?
This is the tricky part to someone’s credit card utilization rate. If you close a credit card, then you can no longer use that card to calculate your credit card utilization ratio.
Let’s look at Nick again. Let’s say that Nick pays off his Bank of America credit card and then closes the account. Here’s what it looks like:
| Credit Card | Balance | Limit |
| Bank of America Credit Card | CLOSED | CLOSED |
| Chase Credit Card | $1,000 | $2,000 |
| Best Buy Credit Card | $1,000 | $5,000 |
| Total | $2,000 | $7,000 |
This means that his new credit card utilization rate is 28.6% ($2,000 / $7,000).
This is the danger of closing credit cards. People like Dave Ramsey preach that you should pay off credit cards and then close them out. While this can, at times, be good advice, just know that it will hurt your credit score because your credit card utilization rate will increase (which is bad) unless you pay down the remaining credit cards.
Certainly, if you find yourself relying on credit cards because you cannot reign in your spending, then closing credit cards is probably a good decision. After all, your credit score going down is a lesser price to pay than paying hundreds (or thousands) of dollars in interest.
(5) How can you improve your credit card utilization rate?
There are four ways to improve your credit card utilization rate. If you find that yours is consistently above 30% you should look into these three steps.
- Pay down your existing credit cards. This is the best way to improve your credit card utilization rate. Obvi. The more you pay your credit cards down, the more money you will have to spend as well because you will not be paying high interest and fees as well.
- Ask for limit increases. If you have a good relationship with your credit card carrier, you can ask for a limit increase. They may or may not have to pull your credit to grant this though. So just be cognisant of that. If they pull your credit, then it will actually ding your credit score a little bit. In my experience it is about 10-15 points for 60-90 days.
- Open new credit cards. This one is the one I would caution against the most. If you don’t have the financial maturity to pay off your credit cards each month, you should not be opening more credit cards. You will likely find yourself in more credit card debt over time.
- Use your credit cards at least quarterly. Most people don’t know this but if you don’t use a credit card for more than three months it won’t affect your credit score. It will still show up on your credit report, but it won’t improve your score. If you want each of your credit cards to improve your credit score then you need to use them at least every three months. I personally use mine at the beginning of each month (at a minimum) for a tank of gas or something small. Afterwards I pay it off as soon as I can see it on my account (usually a couple days later).
(6) Final Thoughts
Credit card utilization is such an important topic when speaking about credit scores and credit reports. If you have a high credit card utilization rate, that’s okay. Just work on paying it down ASAP. If it takes you a few months, that’s okay too. When I first started getting intentional about my finances, my credit card utilization rate was more than 95%. It took me about a year or so, but I gradually paid it down and now it is 0%. My suggestion would be to work on one credit card at a time. If you want to pay off the lowest balance first, that’s cool. Or if you want to pay off the highest interest rate first, that is also cool. It’s up to you. As long as you are doing it aggressively, it won’t make a whole lot of difference.
The main point is to pay off your credit cards. And once you have them paid off, keep them paid off.
It sucks being an adult. But if you want to properly manage your finances, this is one of the pieces.
You can do it!
Until next time!
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