What Is a Credit Utilization Ratio?
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- Your credit utilization ratio, generally expressed as a percentage, represents the amount of revolving credit you're using divided by the total credit available to you.
- Lenders use your credit utilization ratio to help determine how well you're managing your current debt.
- To improve your credit utilization ratio, it's generally best to decrease your outstanding debt. Depending on your situation, it may also be appropriate to consider increasing your credit limits.
Whether you're in the market for a mortgage with a prime interest rate or a small business loan with the best terms, a low credit utilization ratio can help. Here's everything to know about how your credit utilization ratio works and what it means for your access to credit.
What is a credit utilization ratio?
Your credit utilization ratio, generally expressed as a percentage, represents the amount of revolving credit you're using divided by the total credit available to you. A revolving account offers the borrower a steady source of credit that can be used for purchases and paid back multiple times. Credit cards and home equity lines of credit (HELOCs) are two common types of revolving accounts.
Your credit utilization ratio is one tool that lenders use to evaluate how well you're managing your existing debts. Lenders typically prefer that you use no more than 30% of the total revolving credit available to you. Carrying more debt may suggest that you have trouble repaying what you borrow and could negatively impact your credit scores.
How to calculate your credit utilization ratio
To calculate your credit utilization ratio, tally your outstanding debt across all revolving credit accounts. Next, add the credit limits of each individual account together to find your total available credit. Once you have these numbers, divide your outstanding debt by your available credit and convert this number to a percentage to get your credit utilization ratio.
Say you have two credit cards, Card A and Card B. Card A has a $1,000 credit limit and carries a balance of $450. Card B has a $2,000 credit limit and carries a balance of $300. This means your total outstanding debt is $750, and your total available credit is $3,000. Therefore, your credit utilization ratio is $750 divided by $3000, which equals 0.25, or 25%.
How your credit utilization ratio affects your credit scores
In many credit scoring models, your credit utilization ratio accounts for a significant portion of your total score. It's often the second most important factor, following payment history.
Lenders are interested in your credit utilization ratio because it reflects how well you're managing your current debt. It can also help them estimate how successful you are likely to be in repaying any additional borrowed funds.
For example, imagine you have several credit cards, some of which are maxed out, meaning the amount you owe has reached your credit limit. To lenders, this may be a sign that you are spending more than you can afford and you can't reliably pay your bills. So, if they extend additional credit to you, they risk loss. A low credit utilization ratio, on the other hand, shows lenders that you are capable of repaying what you owe. It may also suggest that you could take on additional debt and keep up with your payments.
How to maintain a good credit utilization ratio
To improve your credit utilization ratio, it's generally best to decrease your outstanding debt. However, in some situations, it may also be appropriate to consider increasing your credit limits.
- Reducing your revolving credit balances. The most efficient way to control your credit utilization ratio is to pay down what you owe. Try making a monthly budget and earmark any earnings you can spare for debt repayment.
Remember that revolving credit is structured differently than installment credit. With revolving credit, the amount of debt you hold can fluctuate between monthly billing cycles, depending on how often you make charges to the account. So, when you're working to reduce your credit utilization ratio, try to make payments as soon as you use your credit card. You can also ask your lender when they report your activity to the three nationwide consumer reporting agencies (Equifax, TransUnion and Experian), and pay your bill immediately before that date.
- Increasing your credit limit. Another approach is to increase your total available credit. You can secure additional credit either by opening a new credit card or by asking your lender for a credit limit increase on one of your existing accounts. However, taking out additional credit can come with its own risks.
The credit limits established with your credit cards are based on details of your financial profile, such as your income and credit scores. So, if something about your financial situation has recently changed for the better, you might be eligible for an increased credit limit.
For example, a lender may grant a higher credit limit if your wages have increased recently or if your credit scores have improved. Reliable, trusted customers who regularly pay their debts are more likely to be approved for a higher credit limit. Some lenders even offer automatic credit limit increases for customers who have a proven history of repaying debt.
However, if your ultimate goal is to raise your credit scores, it's important to keep in mind that requesting an increase in your credit limit might trigger a hard inquiry on your credit reports and cause your credit scores to drop temporarily by a few points. Plus, a high credit limit can be a slippery slope, especially if you're already struggling to pay down debt. If you're approved for a higher limit, it's important not to spend more than you can afford to repay.
Remember that if your credit utilization ratio is higher than you'd like it to be, there are steps you can take. A credit utilization ratio at or below 30% can be an asset to your credit scores and help open doors to a bright financial future.