Credit utilization, the percentage of your available credit that you use each month, is a critical component of your credit score which ultimately serves as an indicator of financial restraint and, thus, your ability to handle additional spending power. More simply, most creditors prefer customers who use only a portion of their allotted credit lines because it reflects reasonable spending habits, and such individuals are statistically the most likely to pay their bills on time in the future.
Keeping credit utilization down is easier said than done, however, especially if you’re working with incomplete or inaccurate information. It’s therefore important that we clarify a few things before truly getting down to the business of setting and achieving utilization goals.
Important Points To Remember About Credit Utilization
- Accounts Included: Credit utilization takes into account only the balances and limits on your credit cards and standard lines of credit. Most credit scoring formulas no longer include HELOCs in credit utilization calculations. Installment loans with set payments, such as mortgages and car loans, for example, are not included either.
- Account Utilization vs. Overall Utilization: Credit utilization is calculated for each of your accounts individually – by dividing your monthly statement balance by your credit limit – as well as for all for all of your accounts together. Both types of utilization play a role in credit scoring, but overall utilization tends to be most important.
- 30% Is The Golden Rule, But Too Low Isn’t Optimal: It’s generally recommended that consumers keep credit utilization below 30%, which is good advice that can also be a bit misleading. While maintaining zero utilization is certainly better than maxing out your credit cards, swearing off credit entirely doesn’t necessarily engender confidence among potential lenders because question marks will still remain regarding how you might ultimately leverage the credit made available to you, should the circumstances ever demand it. The best approach is to make sure you are using at least one card each month and paying off the balance in full when the statement comes.
- Everything Is Relative: Not everyone is evaluated according to the same utilization scale. What matters most is how your utilization compares with that of other individuals who are approximately your age and have similar financial profiles in terms of factors such as income and debt obligations.
Setting & Achieving Utilization Goals
You may have heard that credit utilization only matters when it comes time to apply for a credit card or loan, and that’s partially true. Credit utilization is only calculated in the course of tabulating your credit score, and that’s most often done in response to an application for the ability to borrow money. But you can also use credit utilization as an indicator of your own financial stability or to evaluate the progress of budgeting efforts, for instance.
In other words, utilization is something that’s always good to keep an eye on, but you shouldn’t get too hung up on your specific utilization grade unless you have a significant financial event in your immediate future.
Setting Utilization Goals:
- Evaluate Your Starting Point: Consider not only your current utilization but also the overall state of your finances. Are you in debt? Or do you pay your bills in full every month and have high utilization simply because your credit limits are pretty low? Asking yourself such questions will help put utilization into context and will assist you in establishing financial priorities.
Make sure to also take your current credit score into account because it will give you a sense of how impactful reducing your credit utilization might be. For example, if your score is right on the edge of a given credit level (i.e., Excellent, Good, Fair, Limited and Bad), utilization improvements could provide the boost necessary to either solidify your status or reach a higher classification.
- Chart The Course Of Your Immediate Financial Future: Foresight is critical to any utilization-improvement effort, as even a rough understanding of when you plan to purchase a home or buy a car, for instance, will help you establish a timeline. That’s important because the very things that can help you improve your credit utilization in the long run – such as opening a new credit card – often are detrimental to your overall credit standing in the short term. You therefore want to limit surprises as much as possible.
- Establish A Timeline & Set Incremental Goals: With a solid understanding of where your finances are now and what awaits them in the future, you’ll be able to set an overall time-based goal. For example, you might wish to reduce your overall credit utilization from 50% to 30% in the next 24 months because you plan to start shopping for a mortgage around then. Or maybe you want to reduce your utilization on one particular account from 30% to 15% within a calendar year as part of a larger goal to create an emergency fund.
The specifics are up to you; just make sure to confirm your plan is realistic. Think about what you’ll need to do on a daily, weekly and monthly basis to achieve your overall goal. Then establish checkpoints at regular intervals so you can check whether you’re on pace and make adjustments as necessary.
With goals and the framework for a plan in place, it’s time to begin thinking about what specific steps you can take to actually bring about better credit utilization. Reducing utilization – which will be the objective for most people, given how much credit card debt we've racked up in recent years – ultimately comes down to a combination of repaying amounts owed, spending less and garnering higher credit limits.
There are a number of strategies you can employ in the pursuit of these objectives, and we’ll touch on the most substantial ones below.
Achieving Utilization Goals:
- Add To Your Monthly Debt Payments: Some people suggest paying off your smallest balance first, as it will provide a sense of achievement and bring the utilization on one of your accounts to zero. We recommend focusing on the balance with the highest interest rate – while paying the required minimum on the rest – because it is the most expensive. However you decide to approach the problem, you’ll need to attribute more of your monthly budget to debt payments than you currently do in order to change the utilization math.
- Eliminate Luxuries Masked As Necessities: Expenses that once were considered luxuries can easily become necessities in our minds due to simple habit, if nothing else. Habits are hard to break, of course, but something has to go if you’re serious about reducing utilization. Your job is to decide what.
So look over your recent credit card statements, make a list of what you’re spending money on and rank these expenses in order of priority. Afterward, commit to cutting a few of the lowest-priority expenses that you can live without.
- Open A New Credit Card To Increase Your Total Available Credit: Adding available credit without increasing your spending will help reduce your overall credit utilization. The best tool for the job is a credit card with no annual fee because you can keep it open for a long time without worrying about the cost. Keep in mind, however, that applying for and opening a new credit card account can have a temporarily negative impact on your credit score, which means it’s not advisable if you have an important financial event on your calendar in the next six months.
- Ask For A Higher Limit Or Add To Your Deposit: You can reduce utilization on an existing credit card account by requesting a credit limit increase or by adding to your deposit if you have a secured card. While the latter won’t harm your credit score in the short-term, impacting only how much cash you have in the bank, the former will likely result in a hard inquiry.
- Transfer Balances To Get A Lower Rate: If your credit card debt is currently accruing interest at a high rate and you have an above-average credit score, transferring at least part of what you owe to a new credit card could be immediately beneficial to your individual account utilization. And if you use the savings derived from this balance transfer to pay down your principal at a faster rate, this strategy will ultimately prove helpful to your overall utilization, too.
At the end of the day, there’s no real secret to credit utilization, and you shouldn’t try to game the credit-scoring system. Rely instead on the fundamentals – such as budgeting, saving and avoiding unnecessary debt – and both your utilization and your finances in general ultimately will be healthy. For more money-saving tips, make sure to check out our budgeting guide.