The Role of Credit Utilization in Credit Scores

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The Role of Credit Utilization in Credit Scores

Nearly 20% of U.S. credit card holders have maxed out a card due to financial strain.Bankrate reported that this has occurred since the Federal Reserve began increasing in March 2022. 

While it financially supports consumers, maxing out a credit card creates a cascading set of problems for credit card holders. Among them is high credit utilization, which can hurt their credit scores and, in turn, worsen the debt cycle.

How does this happen? Let’s figure it out here. 

The credit utilization rate  

Why Does Credit Utilization Matter for Credit Scores?

Credit utilization is the percentage of available credit that a person is currently using. It’s one of the key factors in determining a credit score, though its impact varies between scoring models. In the FICO® Score, it accounts for 30% of the total score, making it the second most influential factor after payment history (35%). In contrast, the VantageScore model assigns a weight of about 20%, ranking it third after depth of credit (21%) and payment history (40%).

Despite these differences, maintaining a low credit utilization rate is crucial across all scoring models. CNBC reported that most financial experts recommend keeping utilization below 30% for a good credit score, while 10% or lower is ideal for achieving an excellent rating. With these rates, most lenders and other institutions interpret this low rate as not overly reliant on credit to cover expenses, making them lower-risk borrowers.

Keeping utilization under 30% also helps prevent a negative impact on credit scores. Since credit utilization accounts for a significant portion of a credit score (30% in FICO® and 20% in VantageScore), exceeding this threshold can result in a lower score, even if payments are made on time. Note that high utilization may suggest financial overextension, making lenders less likely to approve new credit or offer favorable terms.

For example, consider a borrower with a credit score 555 who has a total credit limit of $10,000 across multiple credit cards but carries a balance of $7,500. According to Experian, one’s credit utilization rate is often calculated by dividing the total credit balance by the total credit limit and multiplying by 100 or using the formula: Credit Utilization Rate = (Total Credit Used ÷ Total Credit Limit) × 100. Following this method, the borrower’s credit utilization rate then is 75% ($7,500 ÷ $10,000 × 100 = 75%), which is significantly above the recommended 30% threshold. 

This high utilization may indicate financial strain, making lenders hesitant to extend new credit. If this borrower reduces their outstanding balance to $2,000, their utilization would drop to 20%, which could help improve their credit score over time and make them a more attractive candidate for future credit opportunities.

Maintaining a low credit utilization rate not only reflects responsible credit management but also helps stabilize credit scores. Frequent fluctuations can occur as scores update based on recent financial activity, and sudden spikes in utilization—such as large purchases or high balances—may temporarily lower scores, even with on-time payments.

Hence, by keeping credit utilization low and stable, individuals can maintain consistency in their credit profile, reducing the risk of unpredictable score changes. Lenders and financial institutions prefer to see steady financial habits rather than sharp increases or decreases in credit usage since fluctuations may indicate financial instability. 

A predictable utilization rate reassures creditors that a borrower is managing credit responsibly, which can strengthen their overall creditworthiness over time.

Does a 0% Credit Utilization Rate Benefit Your Credit Score?

While maintaining a low credit utilization rate is generally beneficial for your credit score, having a 0% utilization rate (i.e., not using any available credit) may not be as advantageous as you might think. 

According to Bankrate, completely avoiding the use of your credit cards can lead to several unintended consequences that could negatively impact your credit score, such as the following: 

1. Inactive Accounts May Be Closed. Credit card issuers may close accounts due to inactivity, which reduces your total available credit. This decrease can lead to a higher overall credit utilization rate if you have balances on other cards, thereby potentially lowering your credit score.

2. Lack of Recent Activity. Credit scoring models favor recent credit activity to assess your current financial behavior. A 0% utilization rate may indicate a lack of recent activity, which can result in a less favorable credit score compared to individuals who use their credit responsibly.

3. Missed Opportunities to Demonstrate Creditworthiness. Regular, responsible use of credit cards, such as making small purchases and paying them off on time, demonstrates to lenders that you can manage credit effectively. This behavior positively influences your credit score, an opportunity missed with a 0% utilization rate.
   
   

While avoiding debt is prudent, completely abstaining from using your available credit can inadvertently harm your credit score. Engaging in modest, regular use of your credit lines is a more effective strategy for maintaining and improving your credit standing.

Maintaining a Credit Standing

Credit utilization affects credit scores in two key ways: it directly impacts score calculations and helps prevent credit score volatility. To optimize credit standing, it’s advisable to maintain a low, ideally under 30%, but not 0% credit utilization rate. For more in-depth or personalized advice, read further or seek professional guidance.