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What Is a Credit Utilization Ratio and Why Does It Matter?
Your credit utilization ratio impacts your credit score.
Understanding your credit score is relatively simple on the surface. The higher it is, the better. But there are several factors that contribute to your score’s calculation and the better you understand them, the easier it could be to boost your score over time.
One of the biggest, and sometimes misunderstood, factors is the credit utilization ratio. This ratio shows how you’re managing your credit card debt and plays a major role in calculating your overall credit score.
Key Takeaways
Your credit utilization ratio compares the balance you’re carrying on revolving credit lines (usually credit cards) against your overall combined credit limit.
A low credit utilization ratio demonstrates responsible borrowing and an ability to make payments on new loans and lines of credit.
You could lower your credit utilization ratio by paying down your credit card balances and increasing your total credit limit.
What Is a Credit Utilization Ratio?
Your credit utilization ratio, sometimes called a credit utilization rate, is the amount of credit you’re using compared to your total available credit. It’s calculated using your revolving lines of credit, including credit cards and personal or home equity lines of credit.1 It doesn’t include installment accounts, like a personal loan, mortgage, or student loan.
The ratio looks at the amount of credit you’re using and compares it against your credit limits. This may be done on an account-by-account basis or in aggregate to examine your total debt against your total limit.2
How To Calculate Your Credit Utilization Rate
Let’s look at a quick example. Say you have a card with a balance of $5,000 and a total credit limit of $8,000. The formula looks like this:
$5,000 / $8,000 = 0.625 or 62.5%
When reviewing your credit score, you may notice that your ratio is being reported as higher or lower than it currently is. This is because credit card companies report your balances to the three credit bureaus monthly and the reported balanced is used for the ratio.3 So, if you made a sizable payment after your balance was reported, it may take a month for the ratio to catch up.
Credit Utilization and Your Credit Score
As you might expect, credit utilization ratios play a major role in calculating credit scores and determining overall financial health. But the exact way your utilization ratio impacts your score depends on the method used to calculate your credit score.
The two main scoring models that most lenders look at are FICO and VantageScore. Your total credit utilization ratio makes up 30%4 of your FICO score calculation and 20%5 of your VantageScore calculation. These models may also consider the highest per-card ratio in their score calculation.6
Per-Card vs Total Utilization
Most credit scoring models look at your total combined credit card utilization ratio rather than looking at each card individually. That said, since your credit score may also consider the highest per-card ratio, having a card near the limit could affect your credit score.7
Let’s see how a per-card ratio compares to an overall ratio.
Say you have the following credit card balances:
Card A: $1,200 on a card with an $11,000 limit
Card B: $800 on a card with a $1,000 limit
Card C: $350 on a card with a $3,200 limit
Your total credit debt across all three cards comes to $2,350, and your total combined credit limit is $15,200. Your overall credit utilization ratio would be calculated as follows:
$2,350 / $15,200 = 0.1546 or 15.46%
Using the same calculation as above at the account level, your per-card ratios look like this:
Card A: 10.91%
Card B: 80%
Card C 10.94%
To improve your credit utilization ratio in this example, paying down Card B would likely have the most immediate impact since it has the highest per card ratio.
How Much of Your Credit Should You Use?
As we mentioned above, low credit utilization has a positive impact on your credit score, and most lenders prefer that you have a credit utilization ratio of 30% or less. This shows them that you’re managing your existing debt well, and if you take on more debt, you’re likely capable of making on-time payments.8
A high ratio doesn’t mean you won’t qualify for a new card or loan, but if it causes your credit score to drop, lenders may ultimately offer you less credit overall and/or charge you more in interest.
Final Thoughts
Understanding your credit utilization ratio may make it easier to improve your credit score and set you up for financial success in the long run. But it’s just one way you could improve your credit score. Another great way to keep your score high is to pay down your existing debt. Not sure how? Learn more about the debt avalanche and debt snowball methods.