What Is Credit Utilization Ratio?

Summary:

Your credit utilization ratio is an important credit score factor. As you lower your credit utilization rate, it may help your credit score.

In this article:

• Credit Utilization Basics
• How to calculate your credit card utilization
• What is a good credit utilization rate?
• How does credit utilization impact your credit score
• How to improve your credit utilization ratio

Credit Utilization Basics

Your credit utilization ratio is a percentage of how much credit you’re using compared to your total credit limit. It’s an important credit score factor, so knowing how to calculate and monitor it is useful to build and maintain a good credit score.

Your credit score, which is a snapshot of your credit health, is based on certain information in your credit report. To create a credit score, credit scoring models look at relevant information in your credit report and place them into factors. Not all credit scoring models are the same, but factors generally overlap. Factors don’t all have the same influence on your credit score — some factors are more important than others. For example, your payment history and credit utilization ratio are two important factors.

In Q2 2023, bankcard balances reached a new record high of $963 billion. Gen Z consumers are acutely impacted — card balances rose over 50% from Q2 2022 to Q3 2022.

Because rising balances can have a negative impact on your credit score, it’s important to act if your credit utilization is high. Learn more about how to calculate your credit utilization and pay down debt so you can improve your credit health:

How to calculate your credit card utilization

Your credit utilization rate looks at the available credit limit of your revolving accounts, like credit cards, and compares it to how much of it you’re actively using. To calculate your credit utilization rate, divide the combined balances on each of your revolving credit accounts by how much available credit you have access to on those accounts (your total credit limit).

Here’s an example:

• You have three credit cards and each one has a credit limit of $2,000
• 3 cards x $2000 = $6000 total credit limit
• The balances across all those cards combine to $3000
• 3000/6000 = 50%

What is a good credit utilization rate?

Popular advice is to keep your credit utilization rate below 30%, but the lower the better. As your credit utilization decreases, it will benefit your score. If you actively use your credit cards and frequently pay them off, your credit utilization rate will fluctuate. Your credit score is derived from information in your credit report, so when you check your credit score, it will reflect the latest information provided by your creditors in your report.

If you made a big purchase but didn’t pay off the balance in full before the card issuer reported it to the credit reporting agencies, your credit utilization rate may be temporarily elevated. If you pay off the balance and maintain a low utilization rate, it should be reflected in your credit report the next time the credit card company provides an update.

How does credit utilization impact your credit score

Your credit utilization is an important credit score factor and if you carry high balances, it could have a negative impact on your credit score. An elevated utilization rate can indicate you have a lot of debt and may have trouble paying it back efficiently. As you pay down your balances and your utilization rate improves, you should see an improvement in your credit score. A lower utilization rate shows you’re able to manage your debt well.

How to improve your credit utilization ratio

Because it’s an influential credit score factor, lowering your credit utilization ratio is an important step to achieving healthy credit. It makes sense, as not carrying large balances can show you’re able to able to manage debt well. Though, not everyone who has a high utilization rate is spending recklessly. Sometimes people are just the victim of circumstances like an unexpected house expense, necessary car repair, or medical bill. No matter how or why your balances grew, it’s important to pay them off as quickly as you can. Here are some things to consider:

Limit credit card usage

Sometimes, the best way to limit credit card debt is to start at the source. If you can, stop using your credit cards for your purchases. It can be difficult, especially if you’re struggling financially. But if you have the means, limiting your transactions to only debit cards or cash can help put a stop to additional, high-interest debt accruing.

Consider keeping cards active

You don’t necessarily need to close your accounts, though. Part of your credit score is based on the average age of your accounts. Closing an account, especially if it has a long history, may negatively impact your credit score. If your credit card has a high annual fee, it may be worth closing, especially if you’re not going to use the card anymore. But if your card has no annual fee, you may want to consider leaving the account open.

Increase your credit card limit

You can ask credit card issuer to increase your available credit. If your balances remain the same and you have a higher credit limit, it should lower your credit utilization rate. But there are a couple important things to note with this strategy. Asking for an increase to your credit limit could trigger a hard inquiry, which may temporarily lower your credit score. Also, you must be mindful of your spending behaviors. If you’ve increased your credit limit, you now have more room on that card to spend without being cut off. If you add charges to the card, your utilization will increase again and you’re not in a better position than before.

Create a budget

If you haven’t created a budget before, this means you’ll need to take a good look at all your spending. See where your money is going and put your expenses into categories. Your bank may have budgeting software built into their online platform, but there are also many apps that can help you as well.

This seems simple, and it can be, but it can also be illuminating. Sometimes spending just gets away from us and we develop money leaks. These would be places or services we forget about and little by little, our money is siphoned to them. Think unused subscriptions, memberships and the like.

When it comes to cutting back, focus on large categories of spending that bring you little value and see if there are consistent purchases you can cut. Our blog post, How To Build a Budget That Works for You, can give you some budgeting techniques.

Create a debt payback plan

When you see where your money is going and find some ways to cut back, you need a plan for that money. Start by listing out all your current debt and the interest rates; this can give you a plan of attack. Making extra payments to outstanding credit card debt is often a smart first move because interest rates on credit cards tend to be higher than other forms of debt. The order in which you choose to pay back your credit cards and other debt will depend on your preference.

A mathematical approach, which means paying back the highest interest rate first, should theoretically save you the most money. But some people like to start with the lowest balance first because it gives them some quick wins and keeps them motivated. It’s up to you to decide what is going to be best for you. Just make sure you’re continuing to make at least the minimum payments on all your credit cards. If you don’t, this could lead to a missed payment being reported on your credit report. Since your payment history is another influential credit score factor, maintaining a positive payment history is important.

You don’t want to neglect saving during this time either, even though it may seem at odds with an aggressive debt repayment strategy. The reason is you’ll always want some money in reserve to cover those sudden, unexpected expenses. Having an emergency fund can help prevent you from needing to use more high interest debt to pay for those bills.

Credit utilization rate is one of those credit terms that may seem confusing at first, but is quite simple when you get the hang of it. The more you check your credit score and read your credit report, the easier it is for you to manage your credit health. And if you’re trying to lower your credit utilization ratio, but still want to build your emergency savings, our blog, Should I Save or Pay Off Debt? shows how you can balance the two.