Calculating Utilization, Let Me Count The Ways

I think I’ve written about utilization, the relationship between the balances and credit limits on credit cards expressed as a percentage, for as long as I’ve owned a computer. But this topic has legs as everlasting as the Gobstopper which shares the adjective. So, for the first time in 2010 and what has to be the 100th time overall, here’s how utilization is calculated.

First off, utilization 101…Mark has a credit card with a $1,000 credit limit. That is, his credit reports show a $1,000 credit limit. His current balance as reported on his credit reports is $500. The utilization of that card is 50% because the balance ($500) divided by the credit limit ($1,000) equals .50 or 50%. Now we can get started.

It’s important to note that the figures I use for my next few examples HAVE to be reported on your credit reports to make these math problems accurate. That’s the bottom line. If it’s not on our credit report then all bets are off.

Line Item Utilization – This is the same calculation as described above for Mark but done for every single open credit card or credit card with a balance. So if you have 10 open credit cards, and open in this examples means it’s not closed, then you’ll have 10 different line item measurements. This is important because the number of highly utilized credit cards on your credit report is a consideration in most credit and insurance risk models.

Aggregate Utilization – This is the same calculation as described above for Mark with one huge difference. For this calculation we are going to combine all of the open credit cards on a credit report to do the math. For example, if I have two credit cards and each has a $5,000 balance and a $10,000 credit limit then I have $10,000 in aggregate balances and $20,000 in aggregate credit limits. Divide $10,000 by $20,000 and you again get .50 or 50%. This measurement is important because the higher utilization the percentage the more risky you are to lenders and insurance companies and the less attractive their terms will be.

High Balance in Lieu of Credit Limits – In some cases your credit cards will not have a credit limit reported. (Note: I’m not talking about charge cards. I’m talking about revolving credit cards that are not reporting a credit limit). In those cases most credit scoring models will look for the historical highest balance, which is typically reported by the credit bureaus, and use that figure in lieu of the missing credit limit. So, if I have a credit card with a $10,000 credit limit but it’s not being reported then the credit score will look for my highest balance figure. If it finds, for example, that your highest historical balance was $7,500 then that’s the figure it will use in lieu of the missing $10,000. So, with my same $5,000 balance and a $7,500 “pseudo limit” I appear to be 67% utilized on that card instead of the true 50%. This is a line item measurement and an aggregate measurement, meaning it is the same regardless of which is being calculated. This practice of withholding credit limits got the credit bureaus sued in a class action case several years ago because Capital One was not reporting credit limits. The case was dismissed because, in my opinion, the court simply couldn’t grasp the details of the problem and the breadth of its impact. Shortly after the lawsuit was filed Capital One began reporting credit limits for the first time in their existence. So, some good did come out of the case.

Missing High Balance and Missing Credit Limit - Now this is a tricky one. In some examples a credit card account will be missing the credit limit and the highest balance. Most credit scoring systems will simply ignore the account for the above referenced utilization calculations because, well, you have no limit to include in the math. This can help the consumer’s scores and it can also hurt the consumer’s scores. For example, if you have a very high balance on that particular credit card but no limit or high credit then that balance can’t increase your aggregate utilization because it’s ignored for that math. It can hurt your score in the example where you have a very low balance relative to the credit limit, which isn’t reported because you don’t get any value of the large difference between the balance and the limit, which is called open-to-buy.

Shadow Limits – A shadow limit isn’t a credit card that’s been left under a leafy tree. Instead it’s the unpublished maximum preset spending limit that all credit cards have, even charge cards that are marketed as not having a preset spending limit. That would suggest that you could use your charge card to buy a $100,000 Mercedes, if the dealership took plastic for such a purchase. And while some very wealthy individuals might be given that amount of shopping power, it’s atypical. The shadow limit is not reported to the credit bureaus so the high balance is the next best figure to use when calculating utilization. And if it’s a charge card the newer FICO scores will not count it in utilization at all. There are, however, revolving credit cards that are also marketed as not having a preset spending limit and, thus, a shadow limit.

The moral of this story is simple; you’d like to do business with credit card issuers who do report the credit limit to all three credit bureaus. It give you the ability to strategically use that card so that you never exceed some self applied utilization percentage. For example, if you know your credit card has a credit limit of $10,000 (and it’s being reported to the credit bureaus) and you never want to exceed 10% utilization on that card then you know you can never allow more than $1,000 to be reported to the credit bureaus as a balance.