Your credit utilization ratio is one of the factors in determining your credit score. So it’s important to understand what it is, how it can change, and how it can impact your score.
What is a credit utilization ratio?
Your credit utilization ratio is your used credit divided by your total credit. It’s a calculation based on your revolving credit – credit that is automatically renewed as you pay off your debts, like a credit card.
How is credit utilization ratio calculated?
If you have one credit card with a credit limit of $500 and you use that credit card to buy something for $100, your current credit utilization ratio would be 20%. The calculation looks like this:
- Your used credit ($100) divided by your credit limit ($500) equals .20 ($100/$500=.20). And .20 converted into a percentage is a 20% credit utilization ratio.
Your credit utilization ratio fluctuates depending on your current balance. If you made $500 worth of purchases on the credit card in the above example, your credit utilization ratio would climb to 100%, meaning you would have used all of your available credit. You would need to pay down that balance to lower your utilization ratio.
What is a recommended credit utilization ratio?
Most financial experts recommend keeping your total credit utilization rate below 30%.
Lenders generally view lower credit utilization more favorably because it can be an indicator that you’re managing your credit well and not overspending. A higher rate may suggest that you’re overextending yourself financially. Credit utilization is just one factor that goes into determining your credit score. But it makes up 30 percent of your score calculation, making it the second biggest factor influencing your score.
What else impacts credit utilization?
Opening new credit cards and closing old ones may impact your credit utilization ratio. Opening a new card will give you more available, unused credit, which may cause your credit utilization ratio to go down. On the other hand, if you close a card with a zero balance, you lose some of your available credit, which may cause your utilization rate to go up.
Similarly, if your bank or credit card company increases your credit card limit, your amount of total credit will go up. And as long as that credit remains unused, your utilization ratio should go down.
What’s the best way to keep credit utilization low?
The best way to keep credit utilization rate low is to have a plan for using and paying off your credit card. By using your card wisely and making payments on time every month (even paying more than the minimum payment), you can keep your credit utilization ratio below 30%. If your credit utilization ratio consistently creeps above 30%, prioritize extra payments and do your best to bring it back down. A budget can be a useful tool for keeping track of your income, expenses, and your credit utilization.
Using your credit card is a great way to build credit. And paying attention to your credit utilization can help you work toward a better credit score. Be aware of your credit limit and current balances. Always have a plan to pay off your purchases. And you can manage your credit utilization rate to your advantage.