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What is Credit Utilization?

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Credit utilization is an important aspect of what makes up your credit score. In fact, even a slight change in your utilization ratio can affect your credit score. That's why it's important to understand what it is and how it works.

Having a good credit score means you'll be able to qualify for better loan rates and terms, which can save you thousands of dollars. Those with lower scores may end up paying more in interest and find it more difficult to be approved in the first place.

Let's take a look at what is credit utilization, what is considered a good ratio, and how to calculate yours.

Credit Utilization Definition

Credit utilization is a fancy way of seeing how much credit card debt you have at any given time. In other words, this ratio looks at the balance you have on all your cards.

The ratio, expressed as a percentage, measures the amount you have on your credit cards — what you're "utilizing" — compared to your overall credit limit. For instance, if you have three credit cards, each with a credit limit of $2,000, you have an overall credit limit of $6,000.

Why is a Credit Utilization Ratio Important?

Your credit utilization ratio is one of the most important factors in how credit scoring agencies such as FICO and Vantage determine your score. Creditors will also use this information to decide whether you're a responsible borrower. Then they'll determine whether or not to increase your credit limit or issue you a new credit card.

More specifically, the higher your credit utilization ratio, the more it indicates you're overspending or spending a large portion of your budget toward debt. This means you're at a higher risk of missing or being late in payments because creditors believe you may be stretched too thin. In turn, your credit score may be negatively impacted.

A high credit utilization ratio could also mean you'll either be denied a loan, or you'll receive a higher interest rate compared to someone with a lower ratio.

The Difference Between Per-Card vs. Overall Utilization

Most scoring models look at your overall utilization rate. That is, comparing your overall debt load to the total amount of credit you're using on all your credit cards. For example, you have two credit cards. Credit card one has a credit limit of $5,000 and you have a $1,500 balance, and credit card two has a credit limit of $3,000 and you have a $500 balance. In this case, your ratio will be based on an overall credit limit of $8,000 and an overall balance of $2,000.

The per-card utilization ratio is also important to help you determine how much of your limit you're using. Calculating the per-card utilization is the same as how you would your overall one. However, you're only looking at an individual credit card's balance compared to the credit limit on the same card.

Going back to the above example, the per-card utilization for credit card one would only look at the $5,000 limit and the $1,500 balance, and credit card two would only take into consideration a $3,000 credit limit and $500 balance.

What is a Good Credit Utilization Ratio?

Most experts and even credit reporting bureaus like Experian recommend you keep your credit utilization ratio below 30%. For instance, if your overall credit limit is $15,000, you should aim to keep your balance below $4,500 at any time.

A low credit utilization ratio generally indicates you responsibly manage your money since you're not relying heavily on debt. It also means you're more likely to manage your debt well by making on-time payments. A higher ratio, as we mentioned above, means you may be having challenges managing your money.

How to Calculate Your Credit Utilization Ratio

Understanding how credit utilization is calculated is fairly straightforward since it relies on a simple ratio.

Here's how you do it:

  1. Find the total credit limit of all your credit cards
  2. Find the total balance on all your credit cards
  3. Divide the total balance of your credit card by the total credit limit
  4. Multiply it by 100 to find the percentage

For example, you have three credit cards, with the following balance and credit limits:

  • Credit card A: $10,000 limit, $2,000 balance
  • Credit card B: $5,000 limit, $600 balance
  • Credit card C: $6,000 limit, $1,000 balance

When added up, it means your total credit limit is $21,000 and your total balance is $3,600. Let's use the formula above to calculate the credit utilization ratio:

  • Credit utilization ratio = total balance / total credit limit
  • Credit utilization ratio = $3,600 / $21,000
  • = 0.17 x 100
  • = 17%

This means you have a credit utilization ratio of 17%, well below the recommended 30%.

How to Improve Your Credit Utilization Ratio

If you have a high credit utilization ratio and are concerned about this being a factor in your credit score, there are several ways to improve it. Each strategy may not be for everyone, so think carefully about your financial situation before making any decisions.

Pay Down Debt

A simple way to lower your credit utilization ratio is to lower your credit card debt. This can be done by paying more than the minimum balance each month, making more than one payment each month, or even consolidating your debt. Every little bit helps. While you're doing this, try not to continue using your credit cards, or you may find yourself right back where you started.

Request a Higher Credit Limit

You can call your credit card company and ask for a credit limit increase. If you've been making on-time payments each month, most credit card issuers will be happy to oblige. Increasing your limit is a faster way to lower your credit utilization. Don't be tempted to rack up a higher balance though.

Open a New Credit Card

Applying for a new card can decrease your credit utilization since it increases your overall credit limit. However, it may affect your credit score temporarily since it requires a hard credit inquiry. Plus, having an additional credit card may tempt you to spend more. Doing so can put you at risk of being stretched thin financially.

Keep Credit Cards Open

Even if you've paid off a card, consider leaving it open so you can maintain your overall credit limit. That way, you can lower your credit utilization ratio, assuming you won't rack up a balance again on that card.

Your Next Steps

If you have a good credit utilization ratio, pat yourself on the back! If not, take the steps above to improve your ratio, and don't forget to keep tabs on it regularly. That means checking your credit card balances and taking action if needed to maintain a low ratio. Doing so will keep your ratio in check and help you maintain or increase your credit score.

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