While many consumers may not be familiar with the term credit utilization ratio, this concept can have a big impact on credit scores. Good credit empowers individuals to get loans for a wide variety of purposes, including paying off debt, purchasing a vehicle, or financing home improvements. That’s not all, however – a good credit score is also key in getting the lowest possible interest rates for all types of loans and credit cards.

Improving your credit utilization could be a simple way to improve your credit score. Read on to learn what credit utilization is and how to make yours more desirable to lenders.

What is a credit utilization ratio?

Your credit utilization ratio can be found by comparing your active balances to your overall credit limit. For example, if your card has a credit limit of $20,000 and you’ve charged $10,000 on it, your utilization ratio would be 50%. That is because technically, you could charge $20,000 on your card – but you’re only using half of the available amount.

How do I calculate my credit utilization ratio?

You can calculate your credit utilization in a few simple steps:

  • First, identify all open credit cards you have in your name. This includes cards you haven’t used in a while. It’s crucial that you don’t overlook any open credit accounts, so take the time to review your records and make sure you have a complete list before moving on to the next step.
  • Second, write down the credit limit for each credit card. This is the maximum amount you can charge on each account. The credit line available on each card may vary widely, as card issuers consider several factors when determining credit limits. These include your past credit history, your income, and their own internal policies. Some credit card issuers list the credit limit for the card on your monthly statement, but you can also call your credit card company for this information. Once you’ve written down each of your cards’ credit limits, add them up to find the total amount of credit available to you.
  • Third, take out your credit card statements and grab a calculator. Add up the outstanding balances across all of your cards.
  • Finally, divide the total amount owed by the total amount of credit available to you. Then, all you have to do is multiply the result by 100 to determine your credit utilization ratio. If you’d like to determine your credit utilization ratio for a specific card, simply take the credit limit on that card, divide it by the amount owed (for that card only), and multiply that number by 100.

An example: John digs through his records and finds that he has three credit cards. His credit limit for each card is:

Card No. 1: $20,000

Card No. 2: $15,000

Card No. 3: $5,000

Adding these sums, we find that John’s credit limit is $40,000. Next, let’s see how much John has charged on each card.

Card No. 1: $8,000

Card No. 2: $10,000

Card No. 3: $1,000

John’s total credit card debt is $19,000. Now, let’s determine John’s ratio. We take John’s total credit card debt of $19,000 and divide it by the amount of credit available to him, which is $40,000.

19,000 divided by 40,000 = 0.475

Next, we multiply the answer by 100.

0.475 x 100 = 47.5

As you can see, John’s credit utilization ratio is 47.5%.

 

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What is a good credit utilization ratio?

Most experts agree that a good credit utilization score is around 30% or lower. Lenders want to see that you’re responsible with credit and can manage debt responsibly, and 30% or lower usage shows you’re not pushing your credit to the limit. However, this is just a guideline and not a hard-and-fast rule. Many experts recommend getting your credit utilization ratio down to 10% to raise your credit score even higher and qualify for the best interest rates available.

At the same time, having a credit utilization score that’s too low can hurt rather than help. Lenders generally frown upon a credit utilization score of zero. They see it as a sign that you may not be confident about being able to pay off a balance, or that you might as well not have that credit card at all. So, even if you’re fortunate enough to not have to use credit cards for everyday purchases, you might want to use a card at least a few times a month to establish a good credit history. Even a minimal credit card balance can help establish this history.

Here are the five factors that determine a credit score:

1. Payment history

Your payment history is the most important factor, making up 35% of your credit score. Lenders want to see that you pay your balances on time. When it comes to credit cards, this doesn’t mean your balances need to be paid in full every month – only the minimum payment needs to be paid on time consistently. With that said, paying off your balance in full each month is a great way to avoid getting into credit card debt.

2. Credit utilization ratio

Your credit utilization ratio determines about 30% of your credit score, making it the second most important factor.

3. Length of your credit history

Credit bureaus will look at the date you opened your oldest and newest credit cards as well as the average age of your credit cards. Generally, the longer your credit history, the higher your credit score will be. This factor makes up 15% of your credit score.

4. Credit mix

Credit bureaus consider the types of credit and mix of credit you have. If you have a car loan, a mortgage, student loans, and a credit card, you’ll probably have a higher credit score than if you had only a car loan. This factor makes up 10% of your credit score.

5. New credit

Credit bureaus look at the number of credit cards recently opened as well as how many hard inquiries lenders make about your credit. Keep in mind, attempting to open too many credit cards or loans in a short period of time can hurt your score. New credit makes up 10% of your credit score.

How to Improve Your Credit Utilization Ratio

Improving your credit utilization ratio doesn’t have to take an incredibly long time. Try taking these simple steps to create a more favorable ratio and improve your credit score.

Pay your balance monthly

This is a very important part of your credit history. Here’s a tip: Insiders know to ask their credit card company for the date they report your balance to credit bureaus. This date is normally the end of the billing cycle and is not the same as your due date. Even if you can’t pay your balance in full, making your payment before the reporting date can help boost your score because it reduces the amount of debt reported to credit agencies from that cycle.

 Increasing your spending limit

Have you gotten a raise since you received a credit card? Have you established a history of paying your bill on time each month? Your lender might increase your spending limit if you ask. This simple step may improve your credit utilization ratio instantly – just be sure not to charge any more to your card once your credit limit is raised.

Apply for an additional credit card

Because your credit utilization ratio focuses on the amount you owe compared to the amount you can charge, opening another credit card may improve your credit score. Be careful, though – too many hard inquiries by lenders, which will occur with a credit card application, can hurt your credit score. Before you apply, make sure the higher credit limit will be enough to make a dent in your credit utilization ratio by going through the steps above.

Pay off credit cards

If you don’t have the funds to pay your credit cards in full, you can look for other ways to pay off credit card debt. For example, applying for a personal loan to pay off credit cards can help lower your credit utilization ratio, even though you’d owe the same amount of money at the end of the day. Some personal loans offer more favorable interest rates than credit cards, which could also help your overall financial wellbeing.

For more information about personal credit, visit our Understanding Credit leaning center.