Credit Utilization: How It Works & How It Affects Your Credit Score
Nowadays credit cards provide the ability to build a credit record and receive a credit score. When you use credit cards responsibly, you have access to additional funds in an emergency.
Credit utilization is the amount of credit that you have already used compared to the total amount of credit that you have available. Take note that this is only based on your revolving credit which is essentially all the lines of credits and credit cards you currently possess. The credit utilization ratio does not include personal loans, auto loans, and even your mortgage. These are factored into the debt-to-income ratio which is not included in the calculation of your credit score.
What is revolving credit, anyway? Well, this is the type of credit that does not have a fixed end date. Instead, the balance (the amount that you owe) carries over from month to month. Each month, you can opt to use more of your available credit, pay some or all the balance, and then borrow against that amount again. If you have not exceeded your credit limit and your account remains in good standing, you can continue to borrow money using your line of credit or credit card. Each month, the amount you borrowed will incur interest unless you pay the balance in full. This helps lower your credit utilization ratio. The lower your credit utilization rate is, the better. So, why is that important? Well, this ratio indicates how well you’re keeping your spending in check and how likely you will be able to pay off any new debt.
How to calculate credit utilization
So, how do you find out what your credit utilization rate is? As we’ve already mentioned, this rate refers to the amount of revolving credit that you have used compared with the total amount of revolving credit you can use. To find out what your credit utilization rate is, follow the step-by-step formula below:
Step 1: Add up all the balances on your credit cards and lines of credit.
Step 2: Add up all the credit limits on all your cards and lines of credit.
Step 3: Divide the total balance by the total credit limit.
Step 4: Multiply the quotient by 100 to get the percentage.
Source, Continue Reading: https://openloans.com/blog/credit-utilization
