Your credit utilization ratio is the percentage of your available credit that you are now using. A high credit utilization ratio (indicating that you are near to maxing out your credit cards) will sometimes damage your credit score. Fortunately, there are several techniques to quickly cut your credit utilization percentage.
Understanding how credit use works, how credit card usage influences your credit utilization rate, and how to calculate your credit utilization ratio are all critical aspects of credit management. Let’s take a closer look at what credit utilization is, why it’s crucial to keep it low, and how a credit utilization calculator may help you monitor your debt-to-credit ratio.
What is a Credit Utilization Ratio?
Your credit utilization is the ratio of total credit to total debt on revolving credit accounts (such as credit cards and home equity lines of credit), and it is typically represented as a percentage. A credit utilization ratio of 25% indicates that you are using 25% of the credit available to you. If you have a single credit card with a $10,000 credit limit, a credit usage percentage of 25% means you presently owe $2,500.
If you have more than one credit card, your credit utilization ratio is the total amount of debt you owe across all of them.
Because credit usage accounts for 30% of your credit score, it’s a good idea to keep your available credit as high as possible—and your obligations as low as possible. Carrying large sums on your credit cards increases your credit utilization ratio and can reduce your credit score.
Credit utilization accounts for up to 30% of your credit score, thus this component is critical. Low usage allows you to earn or maintain a higher credit score, making it easier to qualify for loans and credit cards in the future. When you qualify, you will also be eligible for lower interest rates.
If the other aspects of your credit score are bad, your credit utilization ratio becomes even more significant. Payment history, for example, accounts for 40% of your credit score under the FICO scoring methodology. If you don’t have a lot of credit and payment history, that aspect of your score will suffer. It becomes even more crucial that you keep your credit utilization.
If your credit use rate is excessive and you believe it is affecting your credit score, strive to reduce it. As a starting point, attempt to keep credit card utilization at 30% or lower.
How Does Your Credit Utilization Ratio Affect Your Credit Score?
Under the FICO scoring model, there are five factors that affect your credit score. Each factor makes up a percentage of your total score, as follows:
- Payment history: 35 percent
- Credit utilization: 30 percent
- Length of credit history: 15 percent
- Credit mix: 10 percent
- New credit: 10 percent
As you can see, the most important factor in your credit score is your payment history — which is why late payments have a huge negative impact on your credit score. Your credit utilization ratio is the second-most important factor that affects your credit score. If you are trying to build good credit or work your way up to excellent credit, you’re going to want to keep your credit utilization ratio as low as possible.
Most credit experts advise keeping your credit utilization below 30 percent, especially if you want to maintain a good credit score. This means if you have $10,000 in available credit, your outstanding balances should not exceed $3,000. It’s all right to occasionally make purchases that exceed 30 percent of your available credit, as long as you pay them off within your grace period and avoid turning them into revolving balances or long-term debt.
The average credit utilization ratio of people with perfect credit scores is 6 percent — so keep that in mind as you calculate your own credit utilization ratio and begin the process of lowering it.
How to Calculate Your Credit Utilization Ratio
To determine your credit utilization ratio, add up all of the credit limits on your credit cards. If you don’t know what your credit limitations are, you can find out by entering into your credit card account.
After you’ve calculated your credit limitations, begin adding up your present credit card balances. Divide your debt by your credit and multiply by 100 to calculate the proportion of credit you’re now utilizing, commonly known as your credit usage ratio.
| Balance | Credit limit | Credit utilization ratio | |
|---|---|---|---|
| Card A | $250 | $5,000 | 5% |
| Card B | $1,600 | $6,000 | 27% |
| Card C | $150 | $4,000 | 3.75% |
| Totals | $2,000 | $15,000 | 13% |
If you don’t want to do the math, there are numerous online credit utilization calculators that can help speed up the process. You might also use a credit monitoring tool to compute your credit utilization percentage automatically. The Capital One CreditWise app, for example, recalculates your credit utilization ratio every week and informs you whether any changes have a negative or positive impact on your credit score. CreditWise is free and available to everyone, regardless of whether they have a Capital One credit card, so consider including it in your credit utilization toolset.
How do I Improve my Credit Utilization Ratio?
Unlike some other credit score variables, utilization may allow you to enhance your credit in a short period. Following a late payment or bankruptcy, your credit ratings may take months or years to restore.
Whether you need a quick boost or want to learn how to maintain good credit, here are six techniques to reduce your credit use rate.
1. Pay down your balance early
One tricky point about credit card utilization rates is that your usage depends on the balance that your card’s issuer reports to the credit bureaus, not how much you spend each month. Those two numbers aren’t always the same.
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Also, your issuer may not even report to all three of the major credit bureaus, Equifax®, Experian® and TransUnion® — and in some cases, it may not report to any of them.
Typically, issuers report the balance at the end of your billing cycle.
However, some issuers may send the data at the same time each month for all cardholders, regardless of when your billing cycle ends. Your best bet may be to ask your issuer so you can be certain. What this means is that your issuer may report your billing cycle’s balance before you pay it off. This reported balance will add to your credit utilization.
However, if you pay down part, or all, of your balance before issuers report your balance for the billing cycle, your credit utilization rate for that card will go down.
If you’re working to pay down credit card debts and can’t afford to make partial or full payments early, it can be helpful to stop using your credit cards to make purchases. Otherwise, your new purchases may offset your payments, and your credit utilization rate won’t go down.
Switch to a debit card or cash for your regular purchases, and as you make credit card payments to pay off debt, your credit utilization rate could drop.
3. Pay off your credit card balances with a personal loan
Because credit utilization rates are a reflection of how you use revolving credit, you could take out a personal loan, pay off your credit cards and effectively move the debt to an installment loan (potentially with a lower interest rate than your credit cards). An installment loan is a loan that you repay with a set number of scheduled payments over time. Types of installment loans include auto loans, mortgages and personal loans.
However, there are multiple drawbacks to this approach. You’ll need to qualify for the loan and may have to pay an origination fee on the money you borrow.
And to qualify for the best interest rates on a personal loan, you need to have excellent credit (in addition to other factors). If you have average or poor credit, the interest rate on the personal loan may be higher or lower than that on your credit card(s).
4. Increase your credit limit
Another way to improve your credit utilization rate is to increase your credit limit.
You can call your credit card’s issuer to request a credit limit increase, or you may be able to make the request online. Your card’s issuer may have criteria you need to meet, such as having your account for a specific period of time.
The lender will likely also base its decision on your usage and payment history with the card – so if you have a history of late payments, you’re unlikely to be approved for a limit increase.
Requesting a credit limit increase can result in a hard inquiry, even if the issuer doesn’t approve your request. The inquiry could ding your credit slightly depending on the rest of your credit, although this impact can vary widely depending on the rest of your credit. For example, if you have little credit history, a hard inquiry may impact you more.
Another way to increase your available credit is to open a new credit card.
You won’t necessarily know what the credit limit will be until after you’re approved because it depends on the issuer’s consideration of multiple factors, such as your income and credit history. Some cards may have a minimum credit limit.
As with requesting a credit limit increase, applying for a new card generally results in a hard inquiry regardless if the issuer approves your application./
As you take steps to get your credit in order, you may want to clear out financial clutter by closing credit cards that you don’t often use. While this could make managing your wallet easier, closing an account can also lower your available total credit and increase your credit utilization rate.
The impact of closing an account depends on the credit scoring model. For example, some credit-scoring models may consider the age of your oldest open account. If you close that account, your credit scores could drop.
Which Habit Lowers Your Credit Score?
Credit is one of the most crucial, yet confusing, topics in personal finance. The goal of this post is to help you understand the important components that contribute to your credit score, as well as certain practices you can start right away to help you improve it.
1. Make Your Payments on Time
Your payment history is the most significant factor in calculating your credit score. In fact, it accounts for 35% of your total credit score. Making payments to credit accounts on time is the best way to build a strong payment history and strengthen your credit score.
Late or missed payments can cause your credit score to decline. The impact can vary depending on your credit score — the higher your score, the more likely you are to see a steep drop. Late or missed payments can also stay on your credit report for several years, which is why it is extremely important to avoid them.
To help ensure you are making your payments on time, try setting up automatic payments.
2. Keep your Credit Utilization Low
It is important to understand your available credit and how much of it that you are using. A general guideline is to use no more than 30% of your available credit, and using less is better for your credit score.
The percentage of your available credit that you use is called credit utilization. You can calculate your credit utilization using the following formula:
Credit Utilization Rate = (Total Debt, how much credit you’ve used) / Total Available Credit) x 100
If your current available credit is $5,000 and you make several purchases that total $3,000, you would have a credit utilization of 60%.
To help keep your credit utilization low (under 30%) and avoid maxing out your credit card(s), it is best to not use your credit card in the following situations:
- When you are near your credit limit
- If you don’t have a plan to pay it off
- Paying for non-essentials that are outside of your budget
3. Limit Loan Applications in a Short Period of Time
When you apply for a new loan, lenders will often conduct a hard inquiry, or “hard-pull,” which is where they request to view your credit report as part of the loan approval process. When a hard inquiry occurs, there can be a small drop in your credit score. Applying for multiple loans or credit cards in a short period of time can lower your credit score even more, and signal to lenders you are a high-risk customer.
“Limiting the number of times you ask for new credit will reduce the number of hard inquiries in your credit file. Hard inquiries stay on your credit report for two years, though their impact on scores fades over time”. -Experian
4. Check Your Credit Score
Regularly checking your credit score is the best way to stay up to date on your credit health. This allows you to keep track of increases or decreases to your credit score and stay on top of any fraudulent activity.
Wondering where you can find your credit reports? Go to www.annualcreditreport.com to generate free copies of your credit reports from the three credit bureaus: Equifax, TransUnion and Experian.
A common misconception is that you only have one credit score – this is not true! Different credit bureaus and credit card companies use a range of different scoring models and, as a result, may report different credit scores for the same individual.
The most common scoring model is the FICO score, which is often used when applying for a home loan, car loan or credit card. Based on the FICO scoring model, your credit score will range from 300 to 850. Credit score ratings are:
- 300-579: Poor
- 580-669: Fair
- 670-739: Good
- 740-799: Very Good
- 800-850: Excellent
It’s recommended to check your score at least once a year, as well as before any loan or credit applications. You can also check them more regularly. Checking your credit score is what’s known as a “soft inquiry,” and will not affect your score.
Lastly
Your credit usage ratio is a crucial element in your credit score, so try to maintain it as low as possible. To find out your credit use rate, use a credit utilization calculator or a credit monitoring software.
Reducing your credit utilization ratio is a great method to improve your credit score. If you have a history of high balances and late payments, don’t worry—it is still feasible to improve your credit score. All you have to do is start making on-time payments every month and gradually pay off those loans. As your debt decreases, your credit utilization ratio and credit score should improve.
