Sep 26, 2023
What Is a Credit Utilization Ratio and Why Does It Matter?
A credit utilization ratio, also known as a credit utilization rate or simply utilization rate, is a critical factor in determining your credit score.
It measures the amount of credit you are currently using compared to the total amount of credit available to you. To calculate your credit utilization ratio, divide your outstanding credit card balances by your total available credit limit and then multiply by 100 to get a percentage.
Here's the formula:
Credit Utilization Ratio = (Total Outstanding Credit Card Balances / Total Available Credit Limit) × 100
For example, if you have $2,000 in outstanding credit card balances and a total credit card limit of $10,000, your credit utilization ratio would be:
($2,000 / $10,000) × 100 = 20%
So, in this case, your credit utilization ratio would be 20%.
You can check your credit score and see what your current credit utilization ratio is for free with Borrowell.
Here's why a credit utilization ratio matters:
Impact on Credit Score: Your credit utilization ratio is a significant factor in calculating your credit score. Generally, a credit utilization ratio below 30% is considered good, so that is what we recommend you aim for.
Reflects Responsible Credit Use: Lenders use your credit score to assess the risk of lending to you. A low credit utilization ratio indicates that you are using credit responsibly and not maxing out your available credit, which can be seen as a sign of financial stability.
Can Quickly Affect Your Score: Credit utilization has a relatively high impact on your credit score. If you suddenly max out your credit cards or significantly increase your balances, your credit score can drop significantly in a short time. Lowering your credit utilization ratio is also one of the quickest ways to help improve your overall credit score.
Credit Card Applications: Lenders may be less likely to approve new credit card applications if they see a high credit utilization ratio on your existing accounts. It can signal that you may be taking on too much debt.
Utilization Categories: Credit scoring models often categorize utilization ratios into ranges. Typically, a utilization ratio below 30% is considered good, with lower ratios being even better. Higher ratios, especially above 30% or 50%, can start to negatively impact your credit score.
How to improve your credit utilization ratio:
- Pay Down Credit Card Balances: The most effective way to lower your credit utilization ratio is to pay down your credit card balances. Aim to pay off as much of your credit card debt as possible, ideally in full each month. This will reduce the outstanding balance that's factored into your ratio.
- Increase Your Credit Limit: If possible, ask your credit card issuer for a credit limit increase. This can lower your credit utilization ratio by increasing the total available credit. Be cautious, though, as requesting too many credit limit increases within a short period may trigger a hard inquiry on your credit report, which can temporarily lower your score.
- Open a New Credit Card: Opening a new credit card can increase your total available credit, which can lower your utilization rate. However, this should be done strategically, and you should avoid accumulating more debt. Only open a new credit card if you can manage it responsibly.
- Pay Multiple Times a Month: Credit card balances are reported to credit bureaus once a month. If you make multiple payments during your billing cycle, you can reduce the balance that gets reported. This can be especially useful if you use your credit card frequently but always pay it off.
- Avoid Closing Credit Cards: Closing old credit card accounts can reduce your total available credit, which can increase your credit utilization ratio. If you have older credit cards with no annual fees, it's often best to keep them open, even if you don't use them regularly.
- Use Different Types of Credit: Having a mix of credit types, such as credit cards, installment loans (like a car loan), and retail accounts, can positively affect your credit score. However, only take on new types of credit when it makes financial sense for you.
- Monitor Your Credit Utilization: Regularly check your credit card balances and credit limits. This can help you stay aware of your utilization rate and make adjustments as needed. Many credit card issuers also offer online tools and apps that can help you monitor your utilization. Get your free credit score today from Borrowell to easily keep track of your credit utilization.
- Create a Budget: Develop a budget that allows you to manage your spending and pay down debt more effectively. Reducing unnecessary expenses and allocating more funds toward debt repayment can help you lower your credit card balances.
- Pay on Time: Timely payments ensure that your credit card accounts remain in good standing and don't incur late fees or higher interest rates. Late payments can also negatively impact your credit score.
To maintain a healthy credit utilization ratio, it's generally advisable to pay your credit card balances in full each month or keep your balances well below your credit limits. This demonstrates responsible credit management and can help you maintain or improve your credit score over time.
Knowing your current credit score and credit utilization ratio is the first step in improving it - that’s why we recommend using a free service like Borrowell to monitor your credit score each month. It’s free to sign up and it won’t affect your credit score.