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If you've ever researched factors affecting your credit score, you may have come across the term "credit utilization ratio." It may sound complicated, but it's a really simple idea.
In this guide, we'll explain how credit utilization works and what you need to know to keep your available credit under control.
What is a credit utilization ratio?
Your credit utilization ratio, also known as your credit utilization rate, is the ratio between how much revolving credit -- that is, accounts with balances that vary from month to month, like credit cards -- you're currently using and how much is available to you.
Statistics show that a high credit utilization ratio indicates a higher risk of default on loans, so your ratio has a huge effect on your credit score. Here's what you need to know about yours and how to make it work for you.
How do you calculate your credit utilization ratio?
You calculate your credit utilization ratio on a single card by dividing your current balance by your credit limit and multiplying it by 100. So if you have a $10,000 limit and a $2,000 balance, your credit utilization ratio would be 20%.
Your credit utilization ratio on each card matters as well as your ratio across all of your credit cards. You'd calculate this in more or less the same way. Add up all your current balances and divide this by your total credit limit across all your cards, and then multiply this by 100.
What's a good credit utilization ratio?
The credit utilization rule of thumb is to keep your ratio under 30% and lower if you can. Anything over this is considered to be a high ratio, and this can hurt your credit score as explained below.
It isn't really possible to have a credit utilization ratio that's too low as long as you're using some credit. A low ratio shows that you manage your money well and you don't need to rely heavily on credit to fund your lifestyle. But if you don't use credit at all, lenders have no insight into how you'll handle borrowed money and many will deny you or require a cosigner rather than take a chance that you may default. So make sure you use some credit routinely, even if it's only a small amount.
How does your credit utilization ratio affect your credit score?
Your credit utilization ratio makes up 30% of your FICO® Score, making it the second-most important factor after payment history. It also accounts for 20% of your VantageScore, another popular credit scoring model. VantageScore considers your available credit -- your credit limit minus your current balance -- in its model as well, though this only accounts for 3% of your score.
Your credit utilization ratio can mean the difference between good credit and fair credit or fair credit and poor credit, so you must watch yours carefully. There aren't really strict credit utilization tiers beyond low and high, but usually, the lower your ratio is, the higher your credit score will be and the higher your ratio is, the lower your score will be.
When is credit utilization calculated?
Your credit utilization ratio can fluctuate from day to day, but your credit card issuer usually only reports it to the credit bureau once per month. If you're curious about when your card issuer does this, contact it and ask when your credit utilization ratio is reported.
The once-monthly reporting can be useful to keep in mind, especially if you know you're going to use more than 30% of your credit limit one month. You can make a payment halfway through the month and then another at the end of the month. The credit bureaus will only see your end-of-the-month balance, so your earlier spending won't affect your credit utilization ratio at all.
On the other hand, if you pay off a bunch of credit card debt partway through the month, you may have to wait a few weeks until your credit card issuer next reports to the credit bureaus to see the change in your credit score.
How do you improve your credit utilization ratio?
Once you understand how your credit utilization ratio works, you can take steps to reduce it, if necessary. Here are a few tips:
- Reduce how much you charge to your card every month: The simplest way to lower your credit utilization ratio is to switch to cash when you're approaching 30% of your credit limit, though this may not appeal to everyone as it limits your ability to earn credit card rewards.
- Request a credit limit increase: If you find yourself routinely exceeding 30% of your credit limit, contact your card issuer to request a credit limit increase. You may have to provide updated income information and the card issuer may do a hard inquiry on your credit report, which will drop your score by a few points, but this won't matter if you're approved for the credit limit increase.
- Pay your bill twice per month: As explained above, the credit bureaus only calculate your credit utilization ratio once per month, so if you make a payment halfway through the month and again at the end, you can spend more than 30% of your credit limit and still show a low credit utilization ratio.
- Consider a personal loan: If you can't reduce your credit utilization ratio easily because you're carrying a balance, consider taking out a personal loan to pay off this debt. This will get you a regular monthly payment and possibly a lower interest rate than what you were paying on your credit cards. It'll also reduce your credit utilization ratio.
Your credit utilization ratio has a huge effect on your ability to take out new loans and credit cards and what kinds of interest rates you're offered, so you should definitely keep an eye on yours if you're not already. If your ratio is over 30%, try the above tips to reduce it and keep it low.
About the Author
Kailey has been writing about banks, credit cards, loans, and all things personal finance since 2012. She also writes for The Ascent's parent company, The Motley Fool. Her work has appeared on USA Today, CNN Money, Fox Business, and MSN Money. She's a graduate of the University of Wisconsin and happily lives in the woods of northern Wisconsin where she grew up.
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