Most people understand the basic concept of credit scores: When lenders loan you money, your credit score shows them how reliably you pay it back.
But the way that credit bureaus determine just how reliable you are is more complex. One key factor affecting your score — your credit utilization ratio — has a 30% impact on how bureaus determine your creditworthiness. We’re here to help you understand what this ratio is and how you can manage it effectively to improve your financial health.
What is credit utilization?
Credit utilization is the amount of credit you’re currently using out of the total credit available to you. Think of it like this: If your credit cards and credit lines are buckets, credit utilization is how much water you’ve poured into those buckets compared to how much water they can hold.
Credit utilization ratio is the term for this simple idea — how much of your available credit you’re currently using.
Say you have a credit card with a $1,000 limit and you’ve spent $300. Your credit utilization ratio in this scenario is 30%. A lower ratio usually tells lenders that you’re managing credit responsibly, while a higher ratio suggests that you’re financially stretched.
How to calculate your credit utilization ratio
Ready to crunch some numbers? Here’s a simple formula for calculating your utilization rate:
Credit Utilization Ratio = (Credit Used / Total Credit Limit) x 100
Let’s walk through the formula with the numbers in the example we mentioned before. In this scenario, your credit used is $300. Your credit limit is $1,000. Now we just have to punch those numbers into the formula:
Credit Utilization Ratio = ($300 / $1,000) x 100
Dividing $300 by $1,000 gets you 0.3. Then, multiply by 100 to turn this into a percentage — that’s how we landed on a credit utilization ratio of 30%.
The calculations get a little trickier when you’re working with more than one line of
revolving credit. If that’s true for you, follow these steps to calculate your overall credit utilization ratio.
Add up all of your revolving credit balances. Be sure to include every credit card or line of credit, even if your current balance is zero.
Add up all of your credit limits. Each credit card and line of credit has a limit — the maximum amount lenders will let you borrow. Add them all together to get your total available credit.
Divide your total balances by your total credit limits. Divide the total of your revolving balances from step one by the total of your credit limits from step two.
Multiply the result by 100. Multiplying converts your decimal into a percentage.
So, let’s say across your finances, your credit balances total $700 and your credit limits total $2000. If you divided the total of $700 from step one by the $2,000 from step two, you’d get 0.35. Now all you have to do is multiply that number by 100 to get a credit card utilization ratio of 35%.
Why does higher credit utilization decrease your credit score?
Credit utilization plays such a big role in your credit score because it’s a key measure of how much you rely on credit. Lenders use this ratio (among other things) to gauge how well you’re managing your finances.
When you use a high percentage of your available credit, it can signal financial stress to creditors. They may see it as a sign that you’re struggling to live within your means or at risk of falling behind on payments. This perception can lower your creditworthiness in their eyes, which is why credit scoring models like FICO and VantageScore penalize high credit utilization.
Here’s how it works.
Credit scoring models love balance. Credit utilization makes up about 30% of your overall credit score, making it almost as important as your payment history (which makes up 35% of your score).
High utilization impacts future borrowing. A higher utilization ratio doesn’t just lower your score. It also makes it harder to qualify for loans or credit cards. And if you do get approved, you’re likely to face higher interest rates because
lenders see you as a borrowing risk.
High utilization is a red flag for overspending. Maxing out credit cards or carrying balances close to your limit makes creditors skeptical of your ability to repay, which in turn makes them hesitant to extend more credit.
With all of that being said, your payment history is one of the most important factors in your credit score, making up 35% of your score. Recovering from late payments can take awhile, but with a little determination, making on-time payments and lowering your ratio are both straightforward ways to work toward a better score.
What’s a good credit utilization ratio?
Tips to help lower your credit utilization ratio
If your credit utilization is higher than you’d like, don’t worry — these actionable tips can help you bring it down.
1. Pay down balances
Paying down credit card balances is the quickest and most direct way to lower your utilization ratio. Even making extra contributions beyond the minimum payment can help chip away at your debt and reduce the percentage of credit you’re using. Prioritize cards with the highest utilization to see the biggest impact.
2. Request a credit limit increase
Consider asking your credit card issuer to raise your limit. If they grant the increase, your utilization ratio is likely to go down. For example, if your limit increases from $5,000 to $7,500 and your balance remains at $1,200, your ratio could drop from 24% to 16%.
3. Spread out your spending
Consider dividing your purchases across multiple credit cards. By keeping the balance on each card low relative to its limit, you improve your overall utilization ratio. Just be sure to track your spending carefully to avoid overextending yourself.
4. Make extra payments
You don’t have to wait for your billing cycle to end — make smaller payments throughout the month if you can. This habit may help reduce your balances before they’re reported to credit bureaus, helping keep your utilization ratio in check. This approach is especially helpful if you’re planning a big purchase that might temporarily spike your credit usage.
Frequently asked questions
Is it good to have no credit utilization?
Having no credit utilization might sound ideal, but it can actually hurt your credit score, too. Credit scoring models like FICO and VantageScore reward responsible use of credit, which means showing that you can borrow and pay back money effectively. If you aren’t using any of your available credit, there’s no activity for lenders, card issuers, or credit bureaus to assess.
What’s the difference between a FICO score and a VantageScore?
Both FICO scores and VantageScores are widely used credit scoring models, but they differ slightly in how they calculate your score.
FICO score. The Fair Isaac Corporation (FICO) created this model in the 1980s is used by about 90% of top lenders, weighing payment history and credit utilization heavily.
VantageScore. Developed by the three major credit bureaus (Experian, TransUnion, and Equifax), this newer model factors in payment history and utilization but places more emphasis on total balances and available credit.
Stay on top of your credit score with EarnIn
Understanding your credit utilization ratio is an important part of managing your score. But there’s another step you can take to be more proactive with your financial health: regularly
monitoring your credit.
EarnIn’s
Credit Monitoring tool lets you keep a close eye on your credit score at any time, for free.
With EarnIn, you can check your VantageScore 3.0® by Experian®, and if any major changes to your credit come through, our real-time alerts mean you’ll be the first to know.
Ready to take the next step on your journey to
better credit?
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Please note, the material collected in this post is for informational purposes only and is not intended to be relied upon as or construed as advice regarding any specific circumstances. Nor is it an endorsement of any organization or services.
EarnIn is a financial technology company, not a bank. Banking services are provided by our bank partners on certain products other than Cash Out. Your VantageScore 3.0 from Experian® indicates your credit risk level and is not used by all lenders, so don't be surprised if your lender uses a score that's different from your VantageScore 3.0.
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