You may have heard of credit utilization ratio — or seen it on your monthly credit card statement. But why is it so important?
Your credit utilization ratio plays a big impact on your credit scores. And as we know, having good credit comes with benefits, including an easier time qualifying for loans and credit cards. When you do qualify for financing, lenders may be willing to offer you better rates, which can save you money. In fact, having good credit might even make it easier to find a job.
Here is everything you need to know about your ratio and the impact it might be having on your financial future:
What Is Credit Utilization?
Credit utilization ratio is a comparison between your available credit limit and your current balance.
High utilization rates help lenders predict the risk of doing business with you. Typically, the higher the utilization, the bigger potential for risk (in the lender’s eyes). Credit utilization makes up 30% of your FICO credit score — making it the second-highest factor after payment history.
How to Calculate Credit Utilization
There are two types of credit utilization ratios: per-credit card utilization and total utilization. You can figure out both utilization rates yourself.
How to calculate credit card utilization:
- Add up all your credit card balances
- Add up the credit limit on all your credit cards
- Divide your overall credit card balance by your total credit limit
- Multiply by 100 to get your credit card utilization percentage
You can use the same formula to calculate your per-card utilization. Not sure what your limit is? You can find that on your credit card statement, through your online account, or by calling the credit card issuer.
Per-Card or Total: Which Matters More?
When it comes to your credit score, both ratios play a part.
Credit scoring models like FICO and VantageScore consider both numbers when calculating your credit score. Lenders may also see a maxed-out credit card as high-risk potential, even if you have another credit card with a $0 balance.
The best thing you can do to keep your credit utilization ratio in check is to keep low balances across all your credit cards.
What Is a Good Credit Utilization Ratio?
The lower your ratio goes, the better. FICO reveals that people with excellent credit scores over 785 typically use only 7% of their available credit limit.
But that isn’t always possible for everyone. If you do carry a balance, Experian recommends aiming for a credit utilization ratio of 30% or less. As you go above 30%, your credit score will take a bigger and bigger hit.
It’s also worth noting that the credit utilization which appears on your credit reports isn’t updated in real time when you make a new charge or payment. Instead, it’s generally only updated by the credit bureaus once a month — shortly after the statement closing date on your account. So while you may have paid your balance down (or off) by the due date, it may not be reflected immediately on your credit history and in your credit scores.
You can get around that somewhat by calling your credit card issuer to find your statement closing date and aim to pay your balance ahead of time. However, unless you’re making a major purchase soon, like buying a home, you may not need to actively monitor your credit score that closely. Keeping your credit utilization ratios as low as possible will help improve your credit score overtime.
Lowering Credit Utilization
Ideally, getting to balance $0 will have the biggest impact on both your credit utilization ratio and the amount of interest you’re paying. But we get that isn’t an easy task. In the meantime, you can take steps to improve your utilization:
- Start by paying down the balance on your card with the highest per-card utilization. Once you’re at — or below — 30%, move to the next card.
- Ask your credit card issuer for a higher limit and don’t add to your balance. You may not get one every time you ask, but it can give you some breathing room.
- Set a balance alert. Most providers let you set up text or email alerts when your balance reaches a certain point. Set yours to 30% or lower so you know when you should stop using your credit card until you pay down your balance.
Finally, remember that credit cards can work for you or against you when it comes to your credit scores. It all comes down to how you manage your accounts. To build good credit, make those payments on time and aim to maintain a low credit utilization ratio each month.