What is the credit utilization ratio?

  • Your credit utilization ratio is the percentage of your credit limits that you are using.
  • Your credit utilization ratio is part of the “amounts owed” category, which determines approximately 30% of your FICO Score.
  • Maintaining a lower utilization ratio is best for your credit scores.
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Credit scores consider a variety of information on your credit report to determine your score. An important qualifying factor is your credit utilization ratio, which is a comparison of your revolving account balances and credit limits as they appear on your credit report.

Having a lot of debt can lead to a high utilization rate, which can affect your scores. But your utilization rate is also one of the few important scoring factors that you can quickly change to improve your credit score.

What is the credit utilization ratio?

Your revolving account’s credit utilization ratio is your balance divided by your credit limit, which tells you how much of your available credit you’re using. Credit scoring algorithms consider utilization rates to be an important factor because high utilization has been shown to correlate with a higher risk of someone missing a payment in the future.

That may not be surprising. After all, someone who maxed out their credit cards might be in financial trouble or prone to overspending. As a result, they may not be able to pay all of their monthly payments or handle a new loan or line of credit.

How does the credit utilization ratio affect credit scores?

The credit utilization ratio can often have a significant impact on credit scoresBut the exact effect will depend on the type of credit score (there are many different scoring models) and your overall credit file.

“Each model has its own way of calculating your credit score, including a greater or lesser focus on utilizing your credit,” says Jay Zigmont, Ph.D., a CFP® professional and founder of Plan Live, Learn, a Mississippi-based registered investment advisory firm. Still, utilization is often an important scoring factor. Your credit utilization ratio is part of the “amounts owed” category, which determines approximately 30% of your FICO score.

Credit scoring models may also consider your overall utilization rate (the sum of your revolving account balances compared to your credit limits) and the utilization rate of specific credit accounts. As a result, even if you have a low overall utilization rate, maxing out one of your credit cards could hurt your credit score.

On the positive side, many credit scoring models only consider your current utilization rate. “Most of your credit [score] it’s based on things that take time, like the average length of your credit and how many months you’ve paid on time,” says Zigmont. But if your utilization drops from month to month, that could have an immediate impact on your scores. This is changing with some of the newer scoring models, but many creditors still use older models to screen applicants.

How to Calculate Credit Utilization Ratio

You can calculate your credit utilization ratio by dividing a revolving account balance by your credit limit.

“Only your revolving credit is used in utilization calculations,” says Zigmont. “Credit cards are a common form of revolving credit.” However, other revolving lines of credit, such as a personal line of credit or a home equity line of credit, could also affect your credit utilization ratio.

To do the calculation, check your credit report to find the balance and limit of an account. You can then divide the balance by the credit limit. For example, if your credit card shows a balance of $2,000 and a credit limit of $4,000, then the utilization ratio is 50% because 2,000/4,000 = 0.50.

If you have multiple credit cards or other revolving accounts, you can check each account’s utilization rates and combine the totals to find your overall utilization rate.

Some credit monitoring tools, such as Credit Karma and Experian’s credit monitoring service, will also automatically calculate and display your usage for each credit card and your overall usage ratio.

A trick to reduce the utilization rate of your credit

It’s important to remember that credit balances and limits come from one of your credit reports. These will not necessarily be the same as your current account balance or limit.

Creditors will often report your account details, including the current balance and limit, to the credit bureaus around the end of each statement period. With credit cards, it’s usually about three weeks before the bill is due. As a result, you could have a high utilization rate even if you pay your bill in full each month.

If you’re trying to improve your credit score while frequently using your credit cards, perhaps to earn rewards, try to pay off the balance before your statement period ends. You could even make multiple payments each month. Doing so may reduce your reported balance and resulting utilization rate.

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