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How Credit Utilization Ratio Impacts Your Credit Score

Credit utilization ratio is simply the percentage of your total credit limit you’re using. Find out how it affects your overall credit score. 

By Carla Fried | American Express Credit Intel Freelance Contributor

6 Min Read | November 30, 2020 in Credit Score

 

At-A-Glance

Your credit utilization ratio measures the percentage of your total credit card limits you are currently using.

It plays a key role in determining your credit score.

Keeping your credit card utilization ratio under 30% is a good target.

When lenders and credit card issuers evaluate you as a potential customer, they’re largely interested in your credit score, the number that determines your creditworthiness. And one of the biggest factors that goes into computing your score is your credit utilization ratio, sometimes called your credit card utilization ratio. 

 

Once you understand how to calculate your credit utilization ratio you can take steps to improve it, which in turn can help boost your credit score. That’s the end goal, since the higher your credit score the more likely it is you’ll be approved for credit cards and loans – and the more likely you’ll get better terms, too. 

 

Here are five steps to help you take control of your credit card utilization ratio.

 

Step 1: Understand Why Credit Card Utilization Ratios Matter

When you apply for a credit card, a loan, and sometimes even when you’re setting up a cell phone plan or an account with a utility, the creditor or business checks your credit score as a way to assess if you’re going to be a good client who pays your bills on time. A credit score from FICO is what the financial world turns to most; it’s a three-digit rating that ranges from 300 – you’ve got serious room for improvement – to 850 – you’re a creditor’s dream come true. 

 

Your credit utilization ratio is an important factor in calculating that credit score. The ratio represents the fraction of your total available credit limits on all your credit cards – and other revolving debt, if you have any – that you are currently using. The smaller the fraction, the better. Your credit utilization ratio accounts for 30% of your FICO credit score. Only your track record paying bills on time, which counts for 35% of your FICO credit score, plays a bigger role. 

 

If you’re not yet fluent in credit scores, check out “What Is a Credit Score and How is it Defined?

 

Step 2: Calculate Your Credit Utilization Ratio

A good way to calculate your credit utilization ratio is to create a two-column worksheet that lists your current balance and maximum credit limit for each of your credit cards. The credit limit appears on your monthly statement. Then:

  • Add up all your current balances.
  • Add up all your maximum credit limits.
  • Divide the sum total of your outstanding balances by the total of your credit limits. 

 

A quick example:

  • Card A has a $1,000 balance and a $5,000 limit.
  • Card B has a $500 balance and a $10,000 limit
  • Card C has a $2,000 balance and a $12,000 limit.
  • Total balances equal $3,500 and the total credit limit is $27,000. 
  • Divide $3,500 by $27,000 and, voila, the credit utilization ratio is 13%.

 

Step 3: Aim for a Low Ratio

So, what’s a good utilization ratio? Great question but, alas, there is no exact target for a good credit usage ratio. As a general rule of thumb, keeping it below 30% is considered a smart move. When your rate creeps above 30% it is more likely to hurt your credit score. It’s worth considering, though, that when FICO analyzed its own data it found that people with credit scores in the excellent range tended to have credit utilization ratios of less than 10%.1 To learn more about ranges, read “Credit Score Ranges: What Is an Excellent, Good, or Poor Credit Score?” 

 

If your credit card utilization ratio is above 30%, working to lower it may help improve your credit score. 

 

That said, even FICO doesn’t think you should aim for 0%. FICO suggests that in some instances, having a 0% credit utilization ratio might actually hurt your credit score.2 Seem a bit crazy? Well, if you look at this from the vantage point of the credit scoring algorithms, being able to see how well you manage available credit can say more about your ability to use credit responsibly than if you don’t use the credit at all.

 

Step 4: Pay Down Card Balances to Reduce Your ‘Numerator’

One way to lower your credit utilization ratio is to reduce your total balance, which is the numerator of the fraction credit bureaus use when calculating your credit usage ratio. The numerator is the number above the line of a fraction and the denominator is the number below the line. The smaller the sum of your balances, the lower your credit usage ratio will be. 

 

A popular way to reduce credit card debt balances is to pay the monthly minimum due on every card – on time – and then add more to the payment for the card that charges you the highest interest rate. When the high-rate card balance is wiped out, send the extra money to the card with the next-highest interest rate. For other ideas, read “How to Pay Off Credit Card Debt.”

 

Step 5: Consider Asking for a Credit Limit Increase to Raise Your ‘Denominator’

Another way to lower your credit utilization ratio is to increase your total available credit limit, which is the denominator in calculating your usage. 

 

For instance, if Jane has $3,000 in outstanding balances and her maximum combined credit limit on all her cards is $10,000, she has a utilization ratio of 33% – or $3,000/$10,000. If she’s approved for a $1,500 credit limit increase on one of her cards, her total credit limit rises to $11,500. Assuming she doesn’t increase her spending, the same $3,000 balance means her credit utilization ratio will drop to 26% – $3,000/$11,500. 

 

Of course, Jane’s strategy should only be considered if you are rock-solid confident that you will not actually use the higher credit limit as a license to spend more. 

 

Another way to increase your total available credit limit is to apply for a new credit card. Again, that only makes sense if you are sure you can afford the new limit and won’t be tempted to overspend. If you go this route, keep in mind that there may be a small temporary decline in your credit score when you open a new credit card account. 

 

You can use the free MyCredit Guide Simulator to see how paying down balances or getting a credit limit bump might impact your TransUnion VantageScore, which is a credit score computed by one of the three major credit bureaus.

 

The Takeaway

Your credit utilization ratio – the fraction of your total credit limit that you’re using at any time – has a strong influence on your credit score. Collective wisdom says that if you’re using more than 30% of the sum of all your credit limits, it’s probably lowering your score. And research shows that people with excellent credit scores have credit utilization below 10%. These five steps can help you calculate and manage your credit utilization ratio.

Carla Fried

Carla Fried is a freelance journalist who has spent her entire career specializing in personal finance. Her work has appeared in The New York Times, Money, CNBC.com, and Consumer Reports, among many other media outlets.

 

All Credit Intel content is written by freelance authors and commissioned and paid for by American Express. 

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