Credit Utilization Ratio: What Is It and Why Does It Matter?
Credit utilization ratio is an important factor in personal finance. Understanding what it is and how it affects you can empower you to make more informed financial decisions.
Here are a few things you should know about your credit utilization ratio.
What Is a Credit Utilization Ratio?
A credit utilization ratio (also called a credit utilization rate) measures the amount of credit you’re using compared to the total amount of credit available to you. In simple terms, it measures how close you are to reaching the credit limit of your revolving credit accounts such as a credit card or line of credit. It’s generally shown as a percentage.
What Goes Into Your Credit Utilization Ratio?
Your credit utilization ratio only considers revolving credit accounts. This includes things like credit cards and lines of credit. When calculating your credit utilization ratio, credit score models will look at your total credit balance and your total credit limit across all accounts.
Other types of non-revolving credit, such as personal loans, don’t affect your credit utilization ratio. However, they can still affect your credit health in other ways including payment history and credit mix.
How Do You Calculate Your Credit Utilization Ratio?
There are two ways you can calculate your credit utilization ratio. You can use data from your revolving credit accounts to calculate a total credit utilization ratio or a per-account credit utilization ratio.
To calculate your overall credit utilization ratio, you’ll want to add up all your line of credit and credit card balances, then you’ll do the same for your credit limits. You’ll divide the total balance by the total credit limit and multiply by 100 to get your total credit utilization ratio.
(Total credit balances / Total available credit) x 100 = Total credit utilization ratio
Calculating your credit limit per account is simpler. You’ll simply divide the account balance by the credit limit and multiply by 100. For example, if you had a credit card limit of $2,000 and you were carrying a balance of $500 the calculation would look like this:
(500 / 2,000) x 100 = 25% credit utilization ratio
Does Your Credit Utilization Ratio Affect Your Credit Score?
Yes, your credit utilization ratio can impact your credit score. In fact, it’s one of the most important factors in many credit scoring models, including those used in your FICO Score and VantageScore. Your lender can report your credit utilization to the credit bureaus and it can appear on your credit report. It’s an important indicator of your reliance on credit and how well you manage your credit.
What Is a Good Credit Utilization Ratio?
In general, a low credit utilization ratio is better. Most experts agree that keeping your credit utilization rate under 30% is ideal and can help you maintain a good credit score. This is because a low credit utilization rate signals that you’re using credit wisely and not overextending yourself financially. It’s often seen as an indicator of good financial health.
What Are Some Strategies to Lower Your Credit Utilization Ratio?
Pay down your balances. One of the most direct ways to lower your credit utilization is to pay down your balances. If you can, you should put more money toward paying off your line of credit or credit card debt each month and try not to spend more on those accounts. Accelerating debt repayment not only will reduce your credit utilization ratio, but it can help save you money on interest. Consider budgeting to find places you can cut back and use extra income such as tax refunds or income from a side gig to make additional payments.
Increase your credit limits. You can also lower your credit utilization rate by increasing your amount of available credit. You can contact your lender and request a higher credit limit. This approach requires discipline. The goal is not to see the credit limit increase as an opportunity to spend more but to lower the percentage of available credit you’re using.
Open a new account. Another way to increase the amount of available credit is to open a new credit card or line of credit. This can be effective if you don’t spend on the new card. However, many lenders will check a borrower’s credit when determining approval, so you should keep in mind that these hard inquiries can have an impact on your credit history. You should also consider that some credit card accounts and lines of credit come with additional charges such as maintenance and annual fees.
Set balance alerts. Many credit card issuers will allow you to set up alerts that notify you when your balance reaches a certain percentage of your credit limit. You can use these alerts to make sure you don’t accidentally overspend. Being aware of your balance can help you make adjustments to your spending habits. It’s an easy way to maintain awareness and control over your financial life
Consider a personal loan or balance transfer. If you’re dealing with high-interest debt, something like an installment loan or a balance transfer to a card with a lower interest rate can be a good strategy. These options can help you consolidate your debt into a single payment. Balance transfer cards often offer a promotional period with low or no interest, giving you a window to pay down your balance without accruing additional interest. You should be careful when considering debt consolidation. It’s important to be diligent about not running up balances on the accounts you’ve paid off. If you do, you can wind up with more debt. You should also be sure to read the fine print to ensure you’re aware of any terms and conditions.
DISCLAIMER: This content is for informational purposes only, and should not be considered financial, investment, or legal advice.
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