The Finance Blogger

Credit utilization is a relatively new term that was initiated because many consumers were being penalized for having many credit cards open. We have all found ourselves inundated with credit card applications, stores that offer significant discounts if you open an account with them. Then there are the special offers from the credit card companies themselves. Free debt transfers, low interest rates, travel points etc. The offers go on and on. We cannot help ourselves and end up with a significant number of credit cards. many cards have a $5000 credit limit or larger. Even if you just have 6 cards, that’s a potential $30,000 in debt that could be added to your debt load.

Many people were penalized for having so many credit cards and such large potential debt loads. Their credit scores were lowered due to the potential debt load even though they carried a nil balance and paid their balances in full each month. As a result credit utilization was added to our credit scores as another factor to determine the credit score.

Credit Utilization Defined

Let’s take our sic credit cards as defined early and assume that this person only carries an unpaid balance of $2000 on one of the cards. All of the others have a zero balance. He pays the minimum payment each month and has a good record of paying everything on time. His credit utilization  would be $2000 divided by $30,000 or 6.6% when expressed as a percentage.

Lenders look for a ratio under 30% which is amply met by this consumer. In previous days, most people would close credit card accounts to improve their credit score. Lets assume that this person closed five of his credit cards. Also that he used the one that he has a balance on. His credit utilization would go to 40% and would be well above the objective that many lenders look for.

This consumer would have been better off to keep his five credit card accounts open and just not use them. His credit utilization would still be low and contribute favorably to his total credit score.

There are many other factors that contribute to a credit score. An obvious one is paying all of your monthly bills on time every month. Never have a late payment and repay all debt as quickly as possible.

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