What Is a Credit Utilization Ratio?

Introduction

If you’ve looked into what makes a good credit score, you’ve likely come across the concept of a credit utilization ratio, or credit utilization rate. But what exactly is it, and how important is it to your financial future?

Let’s take a look at what a credit utilization ratio is, why it’s important, how it affects your credit, and how to maintain a good ratio.

What Is a Credit Utilization Ratio?

Your credit utilization ratio (CUR) measures how much of your credit you’re actually using at any given time. And specifically your revolving credit, as opposed to installment loans.

Revolving credit includes credit cards and other lines of credit, like personal and home equity lines of credit (commonly called HELOCs). Revolving credit gives you a set limit to borrow against, and after you pay it down, you can use it again. You just have to make sure you’re making timely payments of at least the minimum due each month so you can keep accessing the credit line.

With that in mind, your credit utilization ratio is whatever portion of your revolving credit lines that you’re using right now. It’s calculated as a percentage of your total available credit.

What Factors Into Your Credit Utilization Ratio?

If you have more than one credit card or line of credit, there are two versions of your credit utilization ratio.

• Individual credit utilization measures how much of one credit line you’re using. It’s one balance divided by that one account’s credit limit.
• Aggregate credit utilization measures an average of how much credit you’re using over all your lines of credit. This calculates the sum of all your balances divided by the sum of all your credit limits.

Either or both of these may be used by potential lenders to determine whether or not you’re operating within a healthy ratio.

What Is a Good Credit Utilization Ratio?

According to financial experts, a “good” CUR is 30% or less, and under 10% is preferred. If you use more than a third of your credit lines, you start to look like you could be in danger of maxing out your cards and going further into debt. So new creditors won’t want to grant you more credit.

Your credit report will usually include both individual and aggregate ratios, so if you’re over 30% on one but under on the others, you may still average out OK. However, a good aggregate ratio is closer to the single digits, or between 1% and 9%. For many lenders, using more than 10% of all your revolving credit combined is still too high.

If you’re now thinking that 0% is even better, it’s actually not. When considering how much of your credit line to use, you want it to be low, but not nothing. A low CUR shows that you’re good at managing your credit, but no utilization doesn’t establish any positive payment history.

You can usually get away with 0% utilization on some of your cards when looking at your utilization on an aggregate basis. But be careful, because you run the risk of those cards being closed for inactivity. And if you don’t use any cards for six months or more, you may end up with no credit score, which makes you “credit invisible.”

How Your Credit Utilization Ratio Affects Your Credit Scores

Your credit utilization ratio affects your credit scores a lot. In fact, it’s so important that you might call it the golden ratio of credit. Now, typically the golden ratio refers to a pattern found in nature and used for millennia by artists and architects around the world. But thinking of your credit utilization ratio as a golden ratio helps emphasize how integrated it is in your financial life. 

Whether we’re talking FICO or VantageScore, your credit utilization ratio is the second-most important factor affecting your credit score. It comes in just behind payment history in both scoring models.

Credit utilization is worth 30% of your FICO credit score, with payment history weighted at 35%. VantageScore lists credit utilization as being “highly influential,” or worth 20% of your score, depending on which version you’re using. Payment history is “extremely influential” at 40% of your score.

In any case, lowering your credit utilization ratio will almost certainly help you raise your credit score.

How To Calculate Your Credit Utilization Ratio

Luckily, your credit utilization ratio is simpler to understand and calculate than the golden ratio, aka phi (φ). Your CUR boils down to simple grade-school math, with a little bit of addition and division.

$$\text{Credit utilization ratio}=\frac{\text{Balance}}{\text{Credit limit}}$$

If you’re calculating aggregate utilization, you have to add up all your balances for the top line, and all your credit limits for the bottom line.

So let’s say your revolving credit consists of three separate credit cards with the following credit lines and outstanding balances:

• CARD 1: $500 limit with $100 balance
• CARD 2: $1,500 limit with $600 balance
• CARD 3: $2,000 limit with $300 balance

The sum of your outstanding balances ($100 + $600 + $300) is $1,000.

The sum of your credit limits ($500 + $1,500 + $2,000) is $4,000.

$$\text{Credit utilization ratio}=\frac{\text{\$1,000}}{\text{\$4,000}}=\text{.25 or 25\%}$$

That would mean you’re currently using 25% of your total revolving credit.

Using the same formula on an individual basis, your ratios are:

• Card 1: 20%
• Card 2: 40%
• Card 3: 15%

However, these ratios are a snapshot in time, and change constantly as you make purchases and payments. Typically your CUR will be reported to credit bureaus once a month, and often it’s at the end of your billing cycle before your new statement is generated.

How To Maintain a Good Credit Utilization Ratio

Even though your utilization ratio changes all the time, you can still move the needle.

With fractions, changing either the top number or the bottom number affects the overall value. So with your outstanding balances on top and credit limits on the bottom, we have three ways to lower your credit utilization ratio.

$$\frac{\text{Balance}}{\text{Credit limit}}$$

1. Reduce your balances

Purchasing less or paying off more of your balances owed will lower your CUR, as long as you don’t lower your credit limits at the same time by closing or decreasing the limits on any revolving credit accounts.

2. Increase your credit limits

Getting more credit through a credit line increase or new credit account will lower your CUR, but only if you don’t increase your outstanding balances at the same time by charging more purchases.

3. Do both together

Lowering your balances by spending less or paying off more, while at the same time increasing your available credit through higher credit lines, is the most effective way to reduce your CUR.

So the key is to lower your balances — by spending less or paying more — or increase your credit limit. And preferably all of these together. However, keep in mind that applying for new credit will likely result in a hard inquiry, which can lower your credit score slightly.

Bottom Line

Once you understand the math behind this golden ratio of credit, lowering your credit utilization is pretty simple. It’s just a matter of spending less, paying more, or increasing your credit lines. But “simple” and “easy” aren’t necessarily the same thing.

The good news is that as you work diligently to reduce your credit utilization ratio, you can expect to see a bump in your credit score. And that may motivate you to continue the journey of lowering your credit utilization ratio, building momentum as you go.

Sometimes reaching that goal means getting a new credit card, which can be a great strategy — as long as you’re dedicated to not filling it up. If that’s the right decision for you, always see if you pre-qualify before applying to avoid any unnecessary hard pulls on your credit report.