Written by: Erica Sandberg
Edited by: Austin Lang
Reviewed by: Jon McDonald
Your credit utilization ratio is an important consideration to lenders, so it is a major factor in your credit scores. Over the years, I have had to dispel quite a bit of harmful misinformation about this number.
Myths abound, and if you don’t get the facts, you just may end up paying more than you need to with unnecessary financing fees. Your credit scores can be negatively impacted, which will affect your future borrowing options.
Ultimately, your credit utilization ratio (CUR) is the amount of credit you’ve used compared to how much is available to you. It’s expressed as a percentage, like 30%.
To clear up the confusion, here is everything you need to know about credit utilization — from how it is calculated to the various ways to keep this ratio in check.
Credit Utilization Ratio Basics
I get it; learning about your credit utilization ratio isn’t exactly . . . thrilling. But it’s a key factor in your credit score calculation. If you want to boost your score in hopes of getting a loan or a mortgage, listen up!
Why Credit Utilization Ratio Matters
A great aspect of lines of credit and credit cards is that they allow you to borrow money in various increments, any time you want. Each of these accounts has a specific credit limit.
As an account holder, you have the right to spend up to your credit limit. It’s a convenience that you may want to take advantage of because it enables you to purchase expensive goods and services and then pay over time. You can send the entire amount of the bill in full, or at least the minimum payment.
However, the amount of your credit limit that you use up matters to lenders. If you want to keep your credit scores in good shape, you’ll also want to delete revolving debt that is too close to the limit very quickly.
Credit utilization is significant in credit scoring models because it indicates the borrower may be overextended and thus in danger of delinquency.
That’s because credit scoring models, such as those developed by FICO and VantageScore, take credit utilization into consideration.
When you have used a considerable portion of your existing credit lines and rolled the debt over from one month to the next, lenders may perceive you to be overextended and thus a credit risk. The assumption can be that you are borrowing money to make ends meet. If that pattern continues, you may start to miss payments and possibly even not pay at all.
Because lenders depend on credit scoring models to give them swift and accurate depictions of your creditworthiness, your credit score will be negatively impacted when your credit utilization ratio is out of balance.
In that case, the credit products you will be eligible for will probably come with higher interest rates and lower limits, which reduces the strength of your borrowing power.
Calculating Credit Utilization Ratio
To calculate your credit utilization ratio, simply divide your revolving credit balance by your credit limit, then multiply that number by 100.
As an example, imagine you have a credit card with a $1,000 credit limit. If you revolve a $900 debt, your credit utilization would be 90% (900 / 1000 x 100 = 90). That would make your account nearly maxed out, putting you in the danger zone.
However, credit utilization ratios are also calculated on all of your revolving credit products. If you have more than one account, add up all of your credit limits, then divide the total of your combined revolving credit balances. Multiply that number by 100.
For example, let’s say you have three credit cards:
- Card A – $1,000 limit, $900 debt = 90% credit utilization ratio
- Card B – $2,000 limit, $300 debt = 15% credit utilization ratio
- Card C – $5,000 limit, $100 debt = 2% credit utilization ratio
In this case, your overall credit utilization ratio would be 16.25%, which is good. Yet because Card A’s credit utilization ratio is so high, that single card can hurt your credit scores.
Ideal Credit Utilization Ratio
Credit scoring models do not publish what constitutes a perfect credit utilization ratio. What we do know is that the less you owe on revolving credit products, the better. With that rationale, zero carried-over debt is ideal.
So what happens when you choose to charge with your credit card and pay the balance incrementally? Your credit utilization ratio will be factored into your score. In general, having at least 70% of your credit limit available to you — both per account and in aggregate — should keep your credit scores in fine shape.
How Credit Utilization Ratio Impacts Your Credit Score
Just about every consumer credit scoring model takes credit utilization into consideration. That includes the most frequently used credit scores: the FICO Score and the VantageScore.
FICO Score vs. VantageScore
The two most commonly used scores are the FICO 8 and the VantageScore 4.0. Each takes the information from your credit file and inputs it into their proprietary algorithms. The scoring range is the same — 300 to 850 — with higher numbers indicating lower lending risk.
- For a FICO Score, credit utilization comprises 30% of your score.
- For VantageScore, credit utilization comprises 20% of your score.
Aside from VantageScore factoring credit utilization as less important than FICO Score, there are other differences to know.
This version of the VantageScore takes into account your credit history and factors in your trended utilization (such as when you may have made only the minimum credit card payments and when you paid in full), but FICO Scores do not.
Other Credit Score Factors
How much of your credit line you have used is only one element of your credit score. Here is where it fits with your FICO score, in percentages. VantageScores uses different percentages but maintains many of the same categories:
| FICO Score 8 Factors | VantageScore 4.0 Factors |
|---|---|
| Payment History: 35% | Payment History: 41% |
| Amounts Owed: 30% | Utilization: 20% |
| Credit History: 15% | Age/Credit Mix: 20% |
| Credit Mix: 10% | New Credit: 11% |
| New Credit: 10% | Balance: 6% |
| Available Credit: 2% |
As you can see, comparing and contrasting the way these two credit scoring models evaluate credit utilization is complex, especially when other factors are added in.
Still, you can be certain that keeping your credit lines open is best practice for a high score, especially when you also make all of your payments on time, for both of these scoring models.
Managing and Improving Your Credit Utilization Ratio
The easiest way to make sure that your credit utilization ratio is always positive is to pay your credit card bills in full. If you charged $500 during that billing cycle, pay that amount. No interest will be added, and you will have your entire credit line open to you again.
Keep track of your charging by monitoring your account online or with the credit card issuer’s app. Before making another purchase, pull up your account information and ask yourself if you can afford to send the entire payment by or before the due date. When you’ve reached your personal limit, suspend charging and send the full amount.
So what should you do when you want to revolve a balance? Choose your card carefully. For example, imagine you have the following cards, but this time, all of the lines are wide open:
- Card A – $1,000 limit
- Card B – $2,000 limit
- Card C – $5,000 limit
You want to purchase a laptop that has a price tag of $1,000 and then pay it off in a few monthly installments. Although you can use any of your cards because each has a sufficient credit line, the most sensible account will be Card C because it has a $5,000 limit.
This way you will only use 20% of that credit line, so it shouldn’t damage your credit utilization ratio. However, if you used Card A, you would be at 100% of your limit, and Card B would put you at 50%.
But what happens if you have existing debt that is already hurting your credit utilization ratios? You can strategically manage your accounts to open up your credit limits:
- Concentrate on the credit card that has the highest credit utilization ratio. Review your budget to know how much you can send to all of your creditors, but pay the most to the one that has the highest balance compared to the credit limit. Once it is down to an acceptable credit utilization level, pay the account with the highest interest the most. This way, you will get out of debt at the lowest cost.
- Request a higher credit limit. If you have made all of your payments on time and have kept the account in good standing, the issuer may agree to increase the limit. If so, the higher limit will instantly expand your utilization ratio.
- Open a 0% APR balance transfer credit card. If you add a new card to your portfolio, it will be added to your total credit card line. The old account will then be empty, and if the new card has a much higher limit, your utilization ratio will benefit again. Additionally, you will have a fixed number of months to pay off the balance without any interest added, which can make debt repayment much more efficient.
- Consider a consolidation loan. By shifting credit card debt to a loan, revolving balances will be at zero, and your credit utilization ratio can improve dramatically. Just be sure you can make the payments since they can be much higher than a credit card’s minimum payment Also, make sure that the interest rate is lower than what you have on the combination of your cards.
With a little finessing, you can improve your credit utilization ratio.
Misconceptions About Credit Utilization Ratio
I hear a lot of myths about credit, and I understand why. It can be a complicated topic with nuances. I’ve heard countless people talk about how their credit scores went down after paying off big debts, like student loans.
While paying off an old loan causes total debt to go down, it also closes an old line of credit, which may reduce the length of your credit history (another factor in calculating credit). These types of nuances can make your head spin.
Carrying a Balance Improves Your Credit Score
Now that you’ve read all of this, you can put the rumor that you have to carry over a balance to create a high credit score to rest. It’s simply not true. Credit scores do rely on your regular activity, though. That means using credit products often and responsibly.
After charging, the issuer will send information about your payment and balance activity to the three credit bureaus — TransUnion, Equifax, and Experian. The bureaus will keep a monthly record of how you are managing your account. Credit scoring models will then jump in once a month and use that data to create credit scores.
When you charge and pay the bill on time and in full, you can guarantee that your credit report is filled with positive data. Since these are the two weightiest factors in both FICO scores and VantageScores, this steady pattern will build your credit scores over time.
If you take out a loan and treat it just as responsibly with consistent payments, your credit scores should escalate even further because it will add a variety of credit products to the mix.
Closing Credit Cards Helps Your Credit Utilization Ratio
So, what should you do with a credit card that you no longer want? You may have heard that closing the account will ruin your credit scores. The truth is that it can shave points off your score, especially if it’s an older account, but even then, the negative effect should be minor and temporary as long as you use your other accounts well.
A credit card’s balance needs to be at zero before you can close it. However, if you are carrying debt on other cards, it will create a higher overall credit utilization ratio.
Therefore, if you do want to cancel an unnecessary, unwanted account, take the steps to reduce the debt you have on other credit cards first. Aim for only having 30% of your credit limit used on each account and in aggregate.
A Low Credit Utilization Ratio is Good For Your Credit Scores
Having counseled countless people on the subject of credit utilization, one thing I know is that most people make it more complicated than it needs to be. My best advice is to treat credit card accounts as payment tools rather than debt instruments. This way, you can enjoy all the benefits of a credit card without jeopardizing your credit score.
And if you do have a high credit utilization ratio today, take action to reduce it. Once it’s back in balance, your credit scores should improve, and your options will open up!
