Definition
Credit utilization rate is a ratio of debt balance to the credit limit(s).
Analysis
Amounts owed on debt accounts affect 30% of your credit scores. One of the key indicators as to the responsible management of credit and finances is the credit utilization rate.
The credit utilization rate can be calculated by dividing the debt balance by the credit limit. A debt balance of $600 on a credit limit of $1,000 would yield a credit utilization rate of 60%.
A credit utilization rate can be calculated on one account, and it can separately be calculated on several accounts collectively. A person with a $600 balance on one card with a $1,000 credit limit and a $0 balance on another card with a $1,000 credit limit would have:
- a 60% credit utilization rate on the first card
- a 0% credit utilization rate on the second card
- a 30% overall credit utilization rate
Each of these factors is important, and is included in credit score formulas. Therefore, closing the account with the 0% credit utilization could cause a drop in the credit score, since the overall credit utilization rate would immediately double.
Credit utilization rates of 90% or more are very dangerous, as it indicates a high likelihood of exceeding the credit limit. Lenders know that additional fees charged for exceeding the credit limit could increase the risk of default.
Some credit professionals recommend keeping your credit utilization rate below either 50% or 30%, both on individual accounts and collectively. The fact is, however, that there is really no rule of thumb other than to try to keep balances as low as possible.
According to Fair Isaac spokesperson Craig Watts, consumers should strive to keep their credit utilization rates on revolving accounts below 25%. Watts said in a later interview that some debt can still reduce a credit score slightly, even if the credit utilization rate is below 25%.
Emily Peters of Credit.com also seconded that stance. Her years at credit bureau TransUnion taught her that credit scores can begin to fall when balances exceed just 10% of your credit limits.
Credit utilization rates on installment loans can also affect credit scores. However, the credit utilization rate on installment accounts does not have as great of an impact as the same calculation on revolving accounts.
