Credit utilization is a ratio that refers to your revolving debt as a percentage of your revolving credit limits. Low credit utilization is essential for a good credit score, which can allow you to achieve a low interest rate when borrowing money. How can you calculate your own credit utilization, what is the best level of debt, and how much credit utilization is too high?

How to calculate your credit utilization

To calculate your credit utilization on any particular credit card or revolving credit line, the process is easy. Simply divide your current outstanding balance by your total credit limit, and then multiply by 100 to convert to a percentage. For example, if I have a $500 balance on my credit card and have a $5,000 credit limit, this translates to credit utilization of 10%.

Woman shopping online with a credit card.

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It can also be useful to calculate your overall credit utilization, as we'll see in the next section. To calculate this, add up all of your outstanding revolving account balances, add up all of your credit limits, and divide the two results.

As an example, let's say that I have the following three credit cards:

  • a $500 balance on a $5,000 limit
  • a $300 balance on a $1,500 limit
  • a $200 balance on a $2,500 limit

Adding the three balances shows that I owe a total of $1,000 between the three credit cards. The total limit of the three cards is $9,000. Dividing $1,000 by $9,000 and multiplying by 100 gives an overall credit utilization of 11.1%.

How credit utilization can affect your credit score

To understand why this is important, you need to understand how credit scoring works. The FICO scoring formula, which is the most widely used type of credit score, depends on the following weighted categories of information:

  • 35%: Payment history
  • 30%: Amounts owed
  • 15%: Length of credit history
  • 10%: New credit
  • 10%: Credit mix

The second category, amounts owed, is the one to notice for our purposes. This doesn't just refer to the dollar amounts you owe to your creditors. Rather, a primary factor in this category is the amount you owe relative to original loan balances, or relative to your credit limits -- also known as your credit utilization.

Furthermore, the FICO formula considers your overall credit utilization, as we discussed earlier, as well as the utilization of your individual accounts. In other words, you can have $50,000 in credit card limits with a total of $5,000 in debt, for a low 10% utilization. However, if all $5,000 is on a card with a $10,000 limit, the 50% utilization on that card could potentially be a negative factor in your score.

Why does FICO care about your credit utilization? In a nutshell, the FICO score is designed to predict the likelihood that a particular borrower will default on his or her debt obligations. If you're "maxed out," or are using nearly all of your available credit, there's a higher probability that this will turn into an unsustainable debt load than if you only used a small percentage of your credit limits. In fact, studies have determined that there's a correlation between higher credit utilization and higher default rates.

What is the ideal credit utilization?

It's tough to say what the optimal credit utilization is, mainly because the exact formula FICO uses to calculate your credit score is a closely guarded secret. However, we do have some guidelines that may be helpful.

First, most financial experts agree that keeping your credit utilization below 30%, both overall and on individual credit lines, is a good rule of thumb.

As far as optimal credit utilization, there's admittedly some debate here, but the consensus seems to be "extremely low but not zero." In other words, there have been confirmed reports of consumers paying off their small credit card balances and their scores dropping drastically with no other changes. In fact, when I interviewed perfect-score-achiever David Howe a few years ago, that's exactly what happened.

On the other hand, my fellow writer Sean Williams, also a perfect FICO score achiever, claims that he pays his bills in full every month, and still maintains a coveted 850.

The average consumer with a FICO score above 800, which is universally considered to be an excellent credit rating, uses just 4% of their total available credit, with no more than 10% utilization of any single credit line. While we don't know the perfect amount of credit utilization, this is a good guideline.

Tips to lower your credit utilization

If you'd like to lower your credit utilization, the most obvious way is to aggressively pay down your credit card debt. However, I completely understand that this is easier said than done for many people.

With that in mind, here are three suggestions you can use:

  • One trick to lowering your credit utilization is to ask your credit card issuers to raise your credit limits. This is usually a matter of making a quick phone call, and many card issuers even allow you to request a limit increase online. Think of it this way: If you have a $400 balance on a credit card with a $1,000 limit, you're using 40% of your credit. If the limit is raised to $2,000, your credit utilization immediately drops to just 20%. Nearly 90% of people who request a credit limit increase are successful in getting one, and doing so could help raise your credit score.
  • Also, keeping old credit cards open, even if you don't need them, can keep your credit utilization low. One caveat: If the card has a high annual fee and the benefits of the card aren't worth the cost, it can still be a smart idea to close it. You can also apply for a new credit card with no annual fee. If you don't plan to use it to carry a balance, it adds to your total credit limit and lowers your overall utilization. Here's a recent list of some of our favorite credit cards without annual fees.
  • Finally, it can be a good habit to pay your credit cards in the middle of the billing cycle. This is especially useful if you tend to pay your balance in full each month. Most credit card issuers report your outstanding balance to the credit bureaus a day before your payment due date, and most will tell you when they report, if you ask. It could be a day early, a week, or more. By getting in the habit of paying before your balance is reported, you could prevent purchases from showing up on your credit report and inflating your credit utilization.

The Foolish bottom line on credit utilization

Smart credit utilization can be an invaluable tool when trying to maximize your credit score. Lower is better, but always try to maintain utilization of less than 30%, both on your individual cards and overall. And if you're struggling to do so, the tricks I mentioned here could help you bring your utilization down and raise your credit score.