Your credit utilization ratio, also known as credit utilization rate, is a primary factor contributing to your credit score. The goal is to have a lower credit utilization ratio if you’re hoping to improve or repair your credit. A high ratio can lower your credit score and prevent you from receiving loans or getting the best rates with credit cards.
Understanding credit utilization and knowing how to calculate your ratio can help you improve your overall credit by knowing where to take action. Here, you’ll learn what it is, why it matters and what you can do to make sure your ratio stays at the ideal level.
A credit utilization ratio is the amount of credit you use compared to the total amount of credit you have. For example, if you have a limit of $1,000 and you’re using $500, your credit utilization is 50 percent.
Credit utilization is a significant factor in determining and understanding your credit score. When you regularly check your credit score and credit report, you can see how much you’re spending and make adjustments as needed. Over time, as you work on your credit card utilization, you should begin to see your credit score rise.
It’s helpful to know that credit utilization only applies to revolving credit. Revolving credit includes credit cards and other lines of credit that don’t involve an installment loan. Installment loans are typically for purchases of home or auto loans.
Revolving loans are based on credit usage that doesn’t have a specified end date. For example, when you use a credit card, payments lower your overall balance and you can continue using that line of credit. With a conventional home or auto loan, you have an end date where the purchase will be paid off.
If you want to learn how to raise your credit score fast, it can be beneficial to know the difference between per-card and total utilization. Each credit card has a max limit, so the ratio of your balance to the max limit for that card is your per-card utilization rate. The total utilization is based on the combined amount of all of your lines of credit.
Let’s use the following as an example. You have:
This means your total credit limit is $3,000 when you add each max limit together. If you were to use $250 on the card with a max limit of $500 with the rest of your cards at a $0 balance, the ratio for that card would be 50 percent, but your total utilization would be 8.3 percent.
The total utilization ratio is going to be the most important of the two because it gives lenders a better idea of how you spend. Let’s say you maxed out that $500 credit card from the example above. Your total utilization would be 16.6 percent, which is still pretty good even though one card is completely maxed out.
Your credit card usage percentage is important to lenders because it signals potential risk. Lenders don’t know you personally, so they use your credit report as an easy way to infer whether or not you’re likely to pay them back. A high credit utilization ratio signals to them that there’s a possibility that you spend more than you may be able to pay back. Having a low utilization ratio shows the opposite.
When you keep your credit utilization ratio low, it indicates to lenders that you’re responsible. A low credit utilization rate doesn’t necessarily mean that you never use credit cards, either. If you pay off your credit card balances regularly, it will keep your utilization rate low.
It is suggested to keep your credit utilization under 30 percent. If your credit utilization is consistently higher, your credit score might take a hit.
To maintain a good credit utilization ratio, it’s helpful to try and avoid spending too much on your credit card and pay off your monthly bill in full. This shows credit lenders that you can responsibly use your credit.
You can calculate your credit utilization ratio with the following formula:
(Outstanding credit balance ÷ credit limit) x 100 = credit utilization ratio
For example, let’s imagine that you have a credit card with a $1,000 limit and you have spent $500:
(500 ÷ 1,000) x 100 = 50 percent
You can use this formula for your total credit utilization as well. First, you’ll need to add the max limits of all of your cards together. Then, add all of your outstanding balances for each card together. From here, you can use the same formula to find the total utilization ratio. Sometimes, it’s helpful to make a credit utilization chart to visualize your totals.
Credit utilization can either help or hurt your credit score, depending on how much is being used. 30 percent of your FICO® score is determined by your credit utilization, and VantageScore considers it “extremely influential.”
Although the optimal utilization rate is under 30 percent, it doesn’t mean that the moment your credit utilization reaches 31 percent your score starts sinking. If you consistently have over 30 percent utilization or are consistently maxing out your credit cards, your credit score will likely go down.
According to FICO, the following are used to calculate your credit score:
A common mistake is closing out a credit card because you think it can lower your credit utilization ratio and your overall score. This is a credit card myth that we’re going to debunk.
Let’s say you have five credit cards with a max limit of $1,000 each, making your total limit $5,000. If you have an outstanding balance of $1,000, your utilization ratio is 20 percent. But, if you were to close out one of those cards and had that same outstanding balance, your utilization ratio is higher at 25 percent.
Basically, lowering your max limit increases your utilization ratio. Even if you aren’t using one of your credit cards, it’s a good idea to keep it open because it assists with keeping your ratio low. Remember that 15 percent of your FICO score is based on credit history, so leaving that account open can also help with the age of the credit line.
Credit utilization changes based on your credit limits and the amount of debt you owe. Here are four ways you can improve your credit utilization.
Should you always carry a balance on your credit card? No! This is one of the most common credit card myths. The truth is that paying off your credit card every month keeps your credit ratio low and strengthens your credit score.
Another way to improve your credit utilization ratio is to simply ask your lender for a higher limit on an existing card. They may take into account some other factors before approving, such as your income and credit history. Some lenders will offer credit limit increases after you’ve been with them for a long time, while you may have to call or write to request a limit for others. Keep in mind, requesting an increase might result in a hard inquiry and lower your score.
Having a higher credit limit improves your overall credit utilization ratio. To increase your credit limit, think about opening another credit card. If you’re having trouble getting approved for a new one, there are a few options that can help build your credit.
Refinancing means moving your debt from one lender to another with different terms. Doing this to your credit card debt can help in more ways than one. First, by combining your credit card debt, you’ll maintain a single monthly payment with a lower interest rate. Second, if your credit cards are still open after transferring your debt, your credit utilization ratio goes down.
Your credit utilization can have lasting effects on your overall creditworthiness. Be sure to take the time to figure out and understand everything going into yours. Sometimes, there are errors on your credit report that are hurting your credit score as well. This is where CreditRepair.com might be able to help.
At CreditRepair.com, we take an in-depth look at your credit report with you to see if there are any errors, like missed payments that you’ve actually paid and work with you to request corrections on your behalf. We also provide ongoing credit monitoring, so we can let you know if it seems like your credit utilization is getting too high. If you’re ready to start repairing your credit, sign up for our services today.
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