Keeping or improving a good credit score can be a tricky balancing act. Your creditworthiness involves many different factors, from the amount of credit that you have to the types of credit and more. But none are as important as your credit utilization ratio.
What is my credit utilization ratio?
To put it simply, your credit utilization ratio is the balance that you’re currently using on one single credit card compared to that card’s credit limit. For instance, if your credit limit is $1,000 and you have a balance of $500, your utilization rate is 50%. Most experts will tell you to keep your ratio below 30% on any card.
Your credit utilization ratio is one of three important factors used to determine your credit score:
- Your payment history.
- Your debt-to-limit ratio.
- Your credit utilization rate.
How does my credit utilization ratio affect my credit score?
The major credit bureaus — Equifax, Experian and TransUnion — use proprietary formulas to analyze your credit history and come up with your credit score. But there is a strong correlation between a high credit utilization ratio and low credit score.
If you owe more than 30% on any one credit card at any point during your monthly billing cycle, it could result in a lower credit score, even if you pay off your balances each month. Every month, your credit card issuers report your balances to the credit bureaus.
However, credit bureaus calculate your scores only as requested. If a request comes in just after you’ve made charges that resulted in a higher credit utilization ratio, you could see a drop in your score.
Guide to your credit history and your free online report
How does a credit utilization ratio fluctuate?
Your credit utilization score increases and decreases with the fluctuating balances on your individual cards.
|Balance and limit||Utilization score|
|If you have a balance of $600 on a card with an $800 limit||Your utilization score is 75%.|
|If you have a balance of $225 on a card with a $1,500 limit||Your utilization score is 15%.|
|If you have a balance of $250 on a card with a $1,000 limit||Your utilization score is 35%.|
Using these examples, you’ll see that the middle ratio is great, because it’s under the 30% threshold. The bottom example is close but not ideal, given it’s higher than 30% (even if only by 5%). That top example at 75%? You want to avoid this scenario.
What about my debt-to-limit ratio?
Your debt-to-limit ratio also affects your credit score. This ratio is the total of your owed amounts or balances compared to your credit limits. Here too, staying under the 30% threshold will help you maintain a good credit score.
To determine your debt-to-limit ratio:
- Add up all of the balances on your credit cards.
- Add up the credit limits on all of your credit cards.
- Divide your total balances by your total limit to find your ratio.
For example, if you have a total balance of $1,500 and a total credit limit of $3,000, then your debt-to-limit ratio is 50% — $1,500/$3,000 = 0.50.
You can lower your debt-to-limit ratio by either taking out a new credit card or by paying off some of your debt.
Can I use my credit utilization ratio to improve my credit score?
Yes — but only if you know how. The simplest thing is to keep an eye on your balances, ensuring that they are under 30% of your limit. However, there are a few workarounds.
Opening another credit card
It may sound counterintuitive, but opening another credit card could improve your credit utilization ratio, which in turn could positively affect your credit score.
Let’s say you have a total credit limit of $1,000 and a total balance of $500. To determine your credit utilization ratio, you’d divide your total balance — or $500 — by your total credit limit of $1,000. Doing so results in a credit utilization ratio of 50%.
When you open up a balance transfer card, your credit utilization ratio goes down. Here’s how:
- You have a $500 balance on your current card. This card has a $1,000 credit limit. Right now, your credit utilization ratio is 50%.
- Now you transfer that $500 balance to another card with a $2,000 credit limit, which brings your credit utilization ratio down to 25%.
This new credit utilization of 25% is certainly a better ratio. However, be cautious with this approach: A new credit card will reduce the average age of your credit accounts, and around 15% of your credit score depends on credit age.
Get your score or work on building it
Paying balances twice a month
Another way that you can improve your credit score is to pay off your balances mid-cycle, instead of waiting for the due date each month. Paying balances down twice a month will keep your credit utilization ratio below the 30% threshold — especially when you know when your credit card issuers report information to each of the credit bureaus. It’s time-consuming, but you can find this out by calling the customer service number for each of your cards. Once you know when they report in, you can ensure that you credit utilization ratio is below 30% by that time.
When does my credit utilization ratio matter the most?
When talking about your credit utilization ratio, you’ll need to consider two important elements: balance transfers and new credit. It makes sense to transfer the balance from a card with a high interest rate to a one with a lower rate. You’ll save money on that in the long run. However, depending on the amount that you’re transferring, you may go over the 30% utilization rate. To avoid dinging your credit, transfer only as much as your situation requires.
If you are new to credit, charging items to your credit card and paying them off a little each month could help you set up a good payment history. But large balances can increase your credit utilization ratio, particularly if you have multiple credit cards with balances. Try to keep your balance under 30%, and pay slightly more than the minimum for a month or two. This will help you build a credit history with a better score.
A better credit score may seem like an unattainable feat. But by understanding the importance of your credit utilization ratio, you can improve it using strategies that can positively affect your score in the long term.