Why Credit Utilization Is Important
What is Credit Utilization?
Credit utilization ratio is the amount of credit used divided by the total amount of credit available. Put another way- your credit utilization represents the percentage of total credit you’ve used in comparison with the total amount of credit that is available to you.
Maintaining the best credit utilization ratio you can is important if you want to build your credit score. But first, how do you even figure out your credit utilization rate?
To calculate your credit utilization rate, just divide your credit balance by your credit limit. For example, say you have one credit card with a 10,000 dollar limit. If you owe $5,000 on that account, your credit utilization rate is 50%. Calculate this number for each of your open credit accounts.
Why Your Credit Utilization Ratio Is Important
Because your credit utilization ratio — which FICO refers to as “amounts owed” — accounts for 30% of your FICO score, it’s an important number. In fact, your credit utilization ratio has the second biggest impact on your score — it weighs in just behind your payment history, which shows lenders how likely you are to pay your bills on time.
To maintain a good credit score, it is imperative that you keep your credit utilization ratio low. Lenders want to see that you’re using your credit — just not all of it. This is an important, yet simple, part of credit education. If you have a very high credit utilization ratio it might indicate you’re maxed out — spending a lot of your income each month on debt payments — and unable to take on more debt.
What Is the Best Credit Utilization Ratio?
Naturally, you want to strive to get the best credit utilization ratio. Aim to keep your credit utilization rate at less than 30%. If you are using more than a third of your available credit, pay down some of those outstanding balances to improve your score — and make yourself more attractive to lenders.
If you have the ability, keep your credit utilization rate under 10% for each credit card you have. Not only will this help your credit score, it also saves you money on interest.
When FICO calculates your rate it uses the balances on your monthly credit card statements — even if you pay off the balance after you get your statement. To get the best credit card utilization ratio, pay off your balances before you even receive your statement.
Keep Your Credit Utilization Ratio Low
One way to keep your ratio low is to not close accounts on which you have a balance. Check out this example:
Your total amount of available credit in your credit report is $40,000 and your total credit balances equal $15,000. Divide your balances by your limits to get your ratio: $15,000 divided by $40,000 = 38% utilization.
If you close six accounts that total $20,000 in credit limits, your total amount of credit will be reduced to $20,000. Now divide your $15,000 balance by your $20,000 line of credit and you’ll get a 75% utilization ratio.
Another way to lower your ratio is to ask your credit card issuers to increase your credit limits. This might not be the easiest solution, however, because your credit limit depends on a number of factors, including your credit history, income and how much time has gone by since your received your last credit limit increase.
In short, keep your accounts active and request credit limit increases every six-months or so.
Credit Utilization Ratio Pitfalls
Unfortunately, your credit utilization ratio isn’t completely in your control. Say one of your credit card companies lowers your credit limit — that will increase your utilization rate and cause your FICO score to go down. The only thing you can do if this occurs is to try to pay down your balances.
Creditors are closing accounts and lowering credit limits in reaction to laws such as the 2009 CARD Act, which changed both consumers’ rights and credit card issuers’ practices. That might mean you’ll find you have this issue even if you do pay your bills responsibly.
The Bottom Line
Having the best credit utilization ratio is an important factor in your overall financial picture. Lenders look at it to help them decide if you’re a risky borrower — and charge higher interest rates on loans if it turns out you are. It’s best to keep your ratio at 30% or below if you want to show lenders that you have plenty of available credit — but that you aren’t using all of it.