What is Credit Utilization Ratio?
Credit utilization ratio measures how much you owe relative to your credit limit. It is usually expressed in the form of percent.
How Is Credit Utilization Ratio Used?
This type of ratio relies more on revolving credit rather than installment credit. Normally, lenders use this particular ratio to identify how much debt a customer is carrying and how much of available credit they are using. The lower the ratio, the more appropriate it will look to lenders as they will find you more reliable and creditworthy to make payments on your debt.
Credit Utilization Ratio Formula
Credit Utilization Ratio = Your Total Debt / Total Available Credit
How to Calculate Credit Utilization Ratio?
There are two ways to calculate your credit utilization ratio.
- For each credit card separately
- Overall basis
Simply, for each credit card, you will have to divide the card balance by card limit. On overall basis, you need to divide total balance present on all cards divided by sum of credit limits.
Credit Utilization Ratio = Card Balance / Card Limit
You can calculate this ratio by yourself. All you need is credit card balances and credit card limits.
Generally, it's good to keep the ratio below 30 percent. This is because above than 30% can badly impact your credit score. In addition, it will become difficult to manage large monthly payments for you. Also, you are likely to face higher interest rates in a late payment event. For instance, if you own credit card with a $1,000 limit, it means you should keep your balance below $300.
Examples of Credit Utilization Ratio
Let's say you have a credit limit of four thousand dollars and you owe two thousand dollars. Here the credit utilization ratio is 50% which is something lenders don't want to see. Make sure to keep the ratio as low as possible.
Let's suppose you have three credit cards. One with a credit limit of $500, second card with credit limit of $1500 and the third one includes credit limit of $2000. Also, let's assume you are having a debt balance on all three cards which is summed to $1000.
Combined Debt Balance = $1000
Combined Available Credit = $500 + $1500 + $2000 = $4000
Writing up these two values into the formula, we can determine the credit utilization ratio as:
Credit Utilization Rate = ($1,000) / ($4,000) = .25 x 100 = 25%
In case 2, your credit utilization rate is 25%. This also refers to the fact that you are using 25% of your available credit limit.
How to Improve Your Credit Score with Credit Utilization Ratio?
Credit utilization ratio is the second most important element in credit score determination. Credit utilization ratio can affect up to 30% of your credit score. A lower credit utilization rate refers to less usage of available credit. Scoring models usually interpret this as ‘a good job’ when not exceeding the balance by overspending. After all, spending money in the given boundaries can help you reach higher score.
Here are few ways where you can improve your credit utilization ratio.
- Try to pay more than minimum every month. Submitting payment twice per month instead of once is a better idea to reduce your credit card balance which ultimately results in a low utilization rate.
- Know how much you are being charged to each card. Keep tabs on your expenses. Make the habit of monitoring your online accounts.
- Make request for a higher credit limit. Extending the limit can result you in reduced credit utilization ratio. Yet, the key is to avoid overspending. For this, you can set balance alerts that will notify you on exceeding a certain limit on your card.