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If you are doing research into your personal or business credit score, you may come across what’s called revolving utilization. On average, Americans use only 23% of their credit limit, meaning 75% of their credit is revolving. However, your credit has a big impact on your business. For example, if you own a business that you’re looking to expand through the use of a loan, your lender may begin to ask you about your personal credit score. In many cases, lenders will review your personal credit score as part of your business credit profile during the business creditworthiness evaluation. They may also use something called a credit card utilization ratio to determine loan qualification.
In these cases, building and maintaining a strong personal credit score will greatly benefit you. There are two primary factors that affect your personal credit score: Your payment history and your revolving utilization. Read on to learn about credit card utilization, how it affects your credit score, and how you can manage it.
A Refresher on Revolving Credit
Before diving into revolving utilization, let’s have a refresher on revolving credit. Credit cards are an example of a revolving credit account where you can have a continuous or “revolving” balance. You are given a credit limit when you’re approved for a credit card.
For example, let’s say you have a credit limit of $5,000 on your new credit card. You use it to buy $1,000 worth of items, so now you have a $1,000 balance and a $4,000 remaining credit limit.
If you pay the entire $1,000, then you’ll again have $5,000 of open credit. Now, if you pay $500, then you have $4,500 of open credit. But now your credit revolves between the balance owed and how much open credit you have available. The minimum payment that you’re required to pay each month depends on how much balance is owed.
Home equity lines of credit and lines of credit are other forms of revolving credit that work like credit cards. With installment loans, you take out a lump sum and pay it back over a set term. Vehicle loans, personal loans, mortgages, and student loans are types of installment loans.
What is Revolving Utilization?
Revolving utilization is the proportion of your credit card balance to your credit card limit. It is also called your debt-to-limit ratio or your credit utilization ratio. Expressed as a percentage, your revolving utilization measures how much your credit limits are in use on each of your credit card accounts.
For example: Say you have a credit limit of $5,000 and a balance of $3,500. Your revolving utilization of $3,500 (balance) divided by $5,000 (limit) = 70% (revolving utilization).
What is a Credit Utilization Ratio?
To take it a step further, your credit utilization ratio takes all your revolving accounts into consideration. That means it takes the balances on all your credit cards and compares them with your total available credit. It is also expressed as a percentage.
You can calculate your credit utilization ratio with the following steps:
- Add all the balances on your credit cards
- Add all the credit limits on your cards
- Divide the total balance by the total credit limit
- Multiply by 100
Here is an example of how a credit utilization ratio is calculated: You have five credit cards with balances of $1,000, $500, $700, $1,000, and $300 which equal $3,500. Each card has a limit of $5,000, $1,000, $1,000, $5,000, and $1,000 for a total of $13,000. If you take your balance of $3,500 and divide it by $13,000 it equals 0.269. Multiplying this number by 100 gives you a 26.92% credit utilization ratio.
How Credit Utilization Affects Your Credit Score
Whether you look at your FICO credit score, or another type of credit scoring system, your credit card utilization is an important factor. The consensus is you should keep your credit utilization ratio at no more than 30%. Keeping your credit utilization even lower is better. Lenders view people who charge too much on their cards, especially if the cards are maxed out, as a higher credit risk. As a result, having a higher credit card utilization will lower your credit score.
Here is a look at what credit utilization percentage could mean for you:
- 75% or more: Borrowers in this range are considered to be the highest risk
- 50% to 75%: This credit utilization looks very risky
- Under 50%: Getting your utilization under 50% should be your first goal so that you look less risky to a lender
- 1% to 5%: Your personal credit score will receive the most points at this credit utilization
Tips for Proactive Revolving Utilization
Managing your revolving utilization will help you maintain a good credit score. Carrying balances on your credit cards will cost you a lot of money on interest. Credit cards typically have interest rates that are a few times more than on a collateralized loan like a car. Keeping out of debt is simply in your best interest. Here are three things you can do to keep your credit score optimized.
Refrain from closing accounts
It’s a common myth that having few accounts makes you look more creditworthy. But you should keep your revolving accounts open, even if you don’t use them. The age of your accounts also factors into your credit score. So closing your accounts, particularly the ones you’ve had for a long time, could actually hurt you. After all, revolving utilization indicates the use of your credit.
Monitor your spending
Avoid overspending on things you don’t need. If you can’t pay the full balance on your credit card each month, review what you’re spending money on. Review your transactions and use a budget to keep your spending in line with what you can afford. This is a significant factor in maintaining a sound financial plan for your business.
Never reach your credit limit
Keep well below your credit limit on your credit cards. Using up most or all of your credit limit is a serious red flag to lenders. If the situation you’re in doesn’t allow you to maintain a credit utilization below 50%, then focus on getting all your accounts under 75% first.
Also, remember that your credit utilization is looked at as a whole and each individual credit account. So if you have a particular credit card with a credit card utilization above 50%, focus your efforts on that account first.