Is High Credit Utilization Bad?

When you get a new credit card, that card comes with a credit limit, or a cap on how much you can charge. While you can technically spend right up to that limit, it's often not a great idea.

Credit utilization is a measure of how much of your available credit you're using. Your utilization is important for a few reasons:

• It impacts your credit score.

• It's an indicator of financial flexibility.

• It can contribute to the cost of using credit.

No single number shows the full picture of your finances. However, credit utilization is an important piece of the puzzle. Understanding credit utilization could help you use this information to your advantage. 

What Is Credit Utilization?

Credit utilization is your balance divided by your credit limit. For example, suppose you have a $10,000 credit line. If you owe $3,000 on that credit line, that means 30% of your available credit is in use. That would make your credit utilization 30%.

Credit utilization is measured in two ways:

• Individually for each line of credit you have

• In total, for all your lines of credit

Lines of credit are revolving debts, meaning you can use them, repay them, then borrow again. Credit cards are the most common form of revolving credit for individuals. Home equity lines of credit (HELOCs) are another well-known type of revolving credit.

The table below shows what your credit utilization would be if you had three credit cards and a HELOC, with balances owed on each:

How Is Credit Utilization Used?

Both your overall credit utilization and the utilization of individual lines of credit are taken into account when calculating credit scores. The higher your credit utilization, the more stretched your finances are considered to be. So, high utilization overall or on any one credit line can hurt your credit score.

Besides its use for credit scores, credit utilization also tells you how much financial flexibility you have. If you have a line of credit with no balance owed, you have plenty of flexibility to borrow when you need to. If your line of credit is fully tapped out, you don't have that flexibility.

Another aspect of credit utilization is as a reminder of how much borrowing may be costing you. This is especially true for credit cards, which tend to have relatively high interest rates. The higher your balance, the more it's probably costing you in interest fees. 

Is High Credit Utilization Bad?

High utilization is bad if you can't afford to repay your balances. Having high utilization one month because of a large purchase, that you then pay in full—that's not bad. But high utilization month after month because you can't afford more than the minimum could be a red flag.

In general, the lower your credit utilization, the better it is for your credit score. A low credit utilization also means you have more flexibility. Still, it's expected that you will have some credit in use much of the time. It's unrealistic to shoot for 0% credit utilization at all times. 

Just be aware that the higher the number goes, the more it may hurt your credit score. Also, a steadily rising credit utilization may indicate that your borrowing is getting out of control.

The 30% Credit Utilization Myth

There's a bit of a myth surrounding a so-called 30% rule for credit utilization. This figure is widely quoted, but it's not based on any documentation from credit scoring agencies. There is no hard-and-fast rule about what is a good or bad credit utilization ratio.

In fact, 30% is above the average credit utilization. Over the past 10 years, the average credit utilization ratio on revolving consumer debt has been 26.3%, according to the New York Federal Reserve data. So anything below that is better than average.

Other Debt Red Flags

The average credit utilization of consumer revolving debt has held pretty steady over the past 10 years. Even so, the total amount of debt owed has risen substantially over that time.

Credit utilization has remained consistent despite rising debt levels because credit limits have also risen over the past 10 years. That's not always a good thing—higher credit limits can lead to over-borrowing. That's part of why consumer debt has been growing so quickly.

This shows that while credit utilization is a useful stat, it doesn't tell the full story. There are some other numbers you should be aware of to monitor your borrowing.

Cost of credit

One measure of credit cost is the total interest you've paid over the past year. This shows you how much your debt is costing. Basically, interest adds to the cost of the items you buy with credit.

Cost of credit is a function of how much debt you have. It also depends on the interest rates you pay. Carrying a lot of debt on high-interest credit cards raises your cost of credit.

Debt-to-income ratio

Your debt-to-income (DTI) ratio shows your monthly debt payments (including mortgage or rent) as a percentage of your pre-tax monthly income. For example, if you spend $2,000 a month on debt and rent, and you make $5,000 a month, your DTI is: $2,000 / $5,000 = 40%.

Lenders look at your DTI when evaluating whether you can afford to take on a new loan. It's also a useful number for the rest of us to be aware of, because it’s a good way to track whether debt is eating up a growing portion of your budget.

Affordability of the debt

This is related to your debt-to-income ratio, but it's not quite the same. People have expenses beyond debt payments that aren't included in your DTI. 

Affordability is simply a question of how easily you can keep up with debt payments on top of your regular living expenses. This doesn't boil down to just one particular statistic—it's more a common-sense matter of how hard it is to make ends meet. 

If debt payments make it hard to keep up with your bills, it's a clear signal to reduce your debt load. 

Direction of debt balances

This is another common-sense measure. Simply put, is your debt rising or falling?

It's natural to go through cycles of taking on debt and then paying it down. On the other hand, if you find your debt does nothing but go up and up over time, you may be headed for trouble. 

Continuous borrowing isn't sustainable, and the cost of borrowing will steadily eat up more of your budget. Eventually, you'll run though your credit limits, and have no more room to borrow. 

If you find debt is rising steadily, it's time to make a change. The sooner you tackle your debt problem, the easier it will be.

5 Ways to Reduce Your Credit Utilization

Reducing your utilization could improve your credit scores and make your debt more affordable. Consider these tips:

1. Pay down balances more aggressively. Making it a habit to pay more than the required minimum on credit card bills is key to keeping debt under control. Also, use lump sums like tax refunds and work bonuses to pay down debt faster.  

2. Rein in spending. The first step in solving any problem is to stop it from getting worse. If you find you're borrowing continually to make ends meet, you need to rework your budget. 

3. Increase credit limits. You can request an increase in the credit limits on existing accounts. A higher credit limit with the same balance could reduce your utilization. Just make sure you don't keep spending on the card once you have a larger limit.

4. Refinance debt. Finding lower-cost options to refinance high-interest credit card debt can help you pay down debt faster. A consolidation loan may help you do this. You need to keep your spending under control once your cards are paid off, though.

5. Negotiate debt relief. If you owe more debt than you can afford to repay, you may be able to negotiate a settlement for less than the full amount you owe. A professional debt relief firm can handle this process for you, or you can attempt it yourself. 

Reducing your credit utilization could help your credit score. It should also give you more financial flexibility. You don't have to let your high utilization define your financial future.