When it comes to your credit score, few things are as important as your credit utilization ratio. Your credit utilization ratio — also known as debt-to-limit — is calculated by dividing your balance on existing credit cards by your available credit limits. Knowing this number – and what affects it – is key to improving your credit score. Here’s how it all works.
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.
How do I determine my credit utilization ratio?
Figuring out your credit utilization ratio is simple with a little math. Here’s how to figure it out:
- 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 instance, if you have $3,000 limit on all of your credit cards and you have a balance of $1,500, your credit utilization ratio is 50%.
Most experts will tell you to keep your ratio below 30% on any account.
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 $350 on a card with a $1,000 limit||Your utilization score is 35%.|
Using these examples, you’ll see that the middle ratio is ideal, because it’s under the 30% threshold. The bottom example is close but it could damage your score given that it’s higher than 30%, even if only by 5%. That top example at 75% is a number you want to avoid.
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 counter-intuitive, but opening another credit card could improve your credit utilization ratio, which in turn could increase your credit score. If you plan on using this strategy, steer clear of store credit cards as they typically come with low credit limits which could be maxed out in just one shopping trip.
Case study: Increasing your credit utilization ratio
When you open up a balance transfer credit 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%.
- You transfer that $500 balance to a new card with a $1,000 credit limit.
- Now you have a $2,000 limit spread between the two cards with a balance of $500, 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 can reduce the average age of your credit accounts and around 15% of your credit score depends on credit age.
- 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 if you know when your credit card issuers report information to each of the credit bureaus.
- Ask for a credit limit increase. By gaining access to a larger line of credit, you’ll be effectively increasing your total credit limit and reducing your credit utilization ratio.
Get your score or work on building it
Can too much credit hurt my credit score?
No, having “too much credit” can’t hurt your credit score directly. However, the number of credit card accounts you have open can indirectly affect your credit utilization ratio. Whether its on one credit card or collectively across all of your existing credit card accounts, using more than 30% of your total available credit can put a dent in your score.
Remember that opening new lines of credit results in a hard pull on your credit score. Too many of these in a short period of time can put a hurting on your credit score in the short term.
When does my credit utilization ratio matter the most?
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 low interest rate credit card because you can save money on that in the long run.
However, depending on the amount that you’re transferring, you may go over the 30% utilization ratio. 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.
The goal of a better credit score may seem like an unattainable feat, but it’s doable. By understanding the importance of your credit utilization ratio, you can improve it by using strategies that can positively affect your score in the long term.