Everything You Should Know About Credit Utilization
The more time we spend talking about money, the more we realize why the financial literacy struggle is real: There are too many terms, like credit utilization, that over complicate what you need to know and why it matters. Credit utilization is very important, but also one of easiest financial concepts to understand...if explained properly.
Let’s start with the first part – credit.
All credit means is “borrow.” This is important, keep reading.
If your friend loans you $5.00, you’re on credit to her for $5.00. Now let’s assume she will only loan you $50.00 in total, forever. If you borrowed $5.00 from her that month (or in total), your credit utilization is $5.00!
Yes, credit utilization is the amount you have on credit with her, or in other words, the amount you borrowed from her. In this case it’s $5.00. That’s it. See what we mean? Easy peasy lemon squeezy. 🍋
But we’re not done yet.
Credit utilization vs. credit utilization rate
People often confuse the term credit utilization with credit utilization rate. Using the above example with your friend, when we throw the word “rate” on the end of the term, things change a little. When figuring out our credit utilization rate, all we do is look at the amount we borrowed ($5.00) relative to the total amount that we can borrow ($50.00).
In this case $5.00/$50.00 = 10%.
So...
10% is your credit utilization rate.
Not too tricky, right?
Why credit utilization matters
There is a reason why credit utilization and credit utilization rate get so much coverage: Both impact your credit score and your credit score impacts things like your ability to buy a home, the interest rate you’re charged if you have to borrow money to buy a home, and the interest rate on your car lease, just to name a few. Yes – your credit score is like a rash that follows you around and won’t bother you too much (if you keep it under control, low) or very hurtful to you (if you let it flare up, high). 😅
It’s in your best interest to make sure that you’re mindful of things like your credit utilization and credit utilization rate, because they impact your credit score. Notice we said mindful, not obsess over. We’re not trying to get you to be financial wizards here, we’re just here to help you learn as you go and make the best, informed decisions.
Mindfulness and credit utilization
Here’s what you need to be mindful about: The higher the percentage of credit you’ve used (in this case, $5.00, your credit utilization) in relation to your available credit ($50.00), the lower your credit score can be.
The reason for this is pretty straight forward. The more you have to borrow relative to what you can borrow on your credit card could mean that money is tight and you’re living off of loans (aka credit, in this case, from your friends). Banks who could lend you money to buy a home care about your borrow to paying ratio, because it signals to them that you may not be able to pay them back if money is tight.
One way to keep your credit utilization rate in check while continuing to build your credit is to put smaller charges on your credit card that you then pay off each month. This shows the banks that you’re a responsible human who can put a little bit on their credit card (your credit utilization) and pay it off each month while keeping the total amount you’re charging low, which keeps your credit utilization rate low. Another tip is to make multiple payments on your card each month, such as setting up a schedule to pay off your credit card each time a paycheck hits.
How to know if you’re doing a good job with credit utilization
Keep in mind that the total dollar amount of your credit used (your credit utilization, which is just $5 in the above example) is not as important as the total percentage (credit utilization rate) of the credit you’ve used. This means across all your credit cards, not just one.
If you have a total of three friends who say they can each loan you $50.00 indefinitely and you’ve still only borrowed $5 from that one friend, your total credit utilization rate is $5.00/$150.00 which is just 3%. A general rule of thumb is to keep the percentage, or credit utilization rate, below 30% so you’re very much in the clear here and can go back to not reading about financial terms or whatever you were doing before you started this article.
Hack your way to a better credit utilization score
Listen. We’re not going to beat around the bush and try to sneak in a plug for Petal here. Instead, we will spell it out for you. 🙃
One of the best ways for you to keep your credit utilization ratio low is to make sure at least one of your credit cards has an above average credit limit that you can borrow against.
Here’s the updated scenario.
Let’s now assume that one of your three friends says they will loan you $100.00. You now have two friends who will loan you $50.00 each and one friend who will loan you $100.00. That’s a total of $200.00 that you can borrow against, and your new credit limit.
Staying below a 30% credit utilization rate is still key here, but you can now charge more at one time without hitting that threshold.
Petal is your $100.00 friend. Petal offers higher credit limits than most of our competitors. We designed it that way intentionally. Why do we do this? Because we know that many individuals are worthy of a higher credit limit and shouldn’t be penalized for not yet having the opportunity to build credit.
