The credit utilization ratio is the balance on your credit card in relation to that card’s line of credit—or, if you have more than one credit card, the total of your combined balances in relation to your total credit limit across all your credit cards. It is expressed as a percentage and is considered the second most important credit rating factor after payment history.
Why is this number so important? And how do you improve it? Read on to find out how using credits affects your scores and what you can do to keep your balance.
Why is the credit utilization ratio important?
According to the FICO scoring model, your credit utilization rate is 30 percent of your credit score. It is based on your revolving credit – your credit card usage and lines of credit. This means that when FICO pulls information from your credit report to calculate your credit score, the ratio of your current balance to your available credit determines almost a third of the calculation. Installment loan use also counts towards your credit score, but has a lesser impact than renewable use.
Credit utilization is an important factor in your credit score as it shows how you are using the credit available to you. If your credit utilization rate is low, this may be a sign that you are managing your credit well and are not prone to overspending.
If, on the other hand, you tend to make the most of your credit cards, your high credit utilization rate can make lenders wonder if you’re under financial stress, or if your large balances indicate you’re borrowing more than you can repay. .
To calculate your credit card usage rate, divide your current balance by your credit limit. For example, if you owe $1,000 on a credit card with a $10,000 line of credit, your credit utilization rate is 10%.
To find your overall credit utilization rate, divide the sum of all current balances by the sum of your credit limits. For example, if you owe $200 on a card with a $5,000 line of credit and $300 on a second card with a $1,000 line of credit, your total credit usage is about 8% (total balance of $500 divided by 6,000 USD in total available credit).
What is the best leverage ratio?
A good rule of thumb is to keep your credit usage below 30 percent. However, this rule is not set in stone.
“There is definitely no hard and fast rule when it comes to determining the percentage used to maintain a good or even excellent credit score,” explains Anna Barker, personal finance expert and founder of LogicalDollar.
“However, the 30 percent rule has come to be widely seen as a game changer. While that’s a good number to base your utilization ratio on, there’s no set number for how to calculate it, especially when you consider how many other factors go into calculating your credit score.”
While the 30 percent rule can be a good benchmark, it’s best to aim to keep credit usage as low as possible – ideally in the single digits.
“I had an expert from Experian on my podcast a few years ago and she mentioned keeping credit usage below 30 percent,” said Robert Berger, contributing editor for Forbes Money Advisor and author of Retire Before Mom and Dad. “. “It turns out that 30 percent is not a magic number. In fact, people with scores of 800 and above typically use only 7 percent of available credit.”
How to improve your credit utilization ratio
Now that you have an idea of what ratio you should aim for, you can start thinking about strategies you can use to achieve it.
Know when your credit card issuer reports balances
It is useful to know how credit reporting works in relation to card balances. Each credit card company has its own schedule for reporting to the three national credit bureaus. Typically, this reporting is generated once a month at the end of the billing cycle.
This means that if you make a payment that significantly reduces your credit usage, it may not affect your credit score until the bureau receives an updated report. Likewise, making a large purchase just before the reporting period may cause your credit utilization ratio to appear higher than usual. Pay off your balances in full each month or make multiple payments throughout the month to keep your credit utilization rate as low as possible whenever it is reported.
Maintain healthy credit usage on every card
It is important to remember both the total use of credit and the use of each card. Even if you keep your overall ratio low, a high balance on one of your credit cards can be a wake-up call to creditors. A high balance on only one credit card can also negatively affect your credit history.
“It’s important to keep this in mind so you don’t take any action that you think might improve your credit score when they actually make it worse,” says Barker. “One example: you max one card and open another where you keep the balance at zero to try and balance the first. In this case, the full use of the first of them may negatively affect your account.
According to Barker, the best way to avoid such issues is to make sure you’re not close to the limit on any of your cards.
“So both points are dealt with at the same time.”
Open new credit cards to increase available credit
Getting a new credit card can improve your credit score. Each new credit card you get gives you more available credit, which can lower your overall credit utilization rate if you don’t turn that new credit into new debt immediately.
However, applying for a credit card raises a serious investigation into your credit, which can negatively impact your credit score. New credit is 10 percent of your FICO credit score, so applying for too many new loans at once can hurt your score more than it helps.
That’s why it’s best to be strategic with your credit card applications. If the only reason you’re applying for a new credit card is to improve your credit utilization rate, your best bet may be to apply for a higher credit limit on one or more of your existing cards. Because this can also cause a hard call to some card issuers, always ask first to make sure this doesn’t happen.
Think carefully before closing old credit cards
Consider closing your credit card with even more caution. This will reduce your overall credit limit, which can increase your credit utilization rate. Closing a credit card can also lower the average age of your accounts. A closed account in good standing remains on your credit report for up to 10 years, but once that closed account disappears from your report, you may see a reduction in the length of your credit history and a decrease in your score. Closing a credit card can also affect your credit balance if the credit card was your only revolving credit account.
If possible, keep your cards open. If you’re considering closing your card because you no longer want to pay the annual fee, you can call the issuer and ask for the card to be replaced with a no-annual version. So you can keep your account open and get the card terms that suit you best.
How to minimize credit usage while maximizing rewards
You may be wondering how low credit usage can affect your credit card rewards. This is the right question, as an increase in credit card spending results in an increase in cashback, points or miles, especially if you are working towards meeting the spending requirements for signup bonuses.
The truth is that keeping the credit utilization rate on your bonus card at 0 percent or close to zero is the best way to get the most out of the card.
One way to do this is to treat your bonus card like a debit card. If you take a significant amount on it, pay it off immediately. This will help you avoid paying interest – and a large balance will not be reported if you pay it off before the end of the billing cycle.
“You maximize credit card remuneration by never paying interest and maintaining a zero balance when your credit activity is reported to the bureau,” says Adam Selita, CEO of The Debt Relief Company. “Paying 20 percent on a credit card that offers 2 percent cashback is a moot point. This is definitely not the right way to maximize your benefits as you are returning all the rewards you may have received.”
bottom line
If you want to get an excellent credit score, it’s important to know how credit works. Keeping your credit utilization rate below 30 percent at all times and aiming for less than 7 percent can help you maintain good or excellent credit.
Since your credit utilization ratio is the second largest component of your FICO credit score, keeping a low balance on all your credit cards will help you keep your credit in good condition. Not sure about your credit utilization rate? Use our Loan Usage Calculator to find out where you are.
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The editorial content on this page is based solely on the objective judgment of our contributors and is not based on advertising. It was not provided or ordered by credit card issuers. However, we may receive compensation when you click on links to our partners’ products.