Your credit score is an integral part of your financial life since it dictates how responsible you are and have been with your money. A significant factor in calculating your credit score is credit utilization — the percentage of the credit you are currently using compared to the amount of available credit you have. The higher your credit utilization rate, the lower your credit score may be.
Understanding what your credit utilization ratio is and how you can improve it will help you work toward a good credit score, giving you easier access to the financing you need when you need it. Here’s what you need to know about what is included in your credit utilization ratio, how to calculate it, where it should stand, and steps you can take to improve it.
In this guide:
- What Is Included in Your Credit Utilization Ratio?
- How to Calculate Credit Utilization
- What Is a Good Credit Card Utilization Ratio?
- How to Improve Your Credit Utilization Ratio
What Is Included in Your Credit Utilization Ratio?
Although your credit score is comprised of several different factors related to all credit accounts, your credit utilization ratio does not include each of these driving forces. Only revolving credit accounts, such as credit cards or a home equity line of credit, are used to calculate your credit utilization rate. Accounts such as student or personal loans, auto loans, and mortgage loans are not included.
How to Calculate Credit Utilization
The first step in knowing how to calculate your credit utilization is recognizing what’s included in the calculation. Now you simply add up all your revolving credit account balances currently owed and divide the total balance by your total credit line. For example, if your total credit limit across all of your credit cards is $20,000 and you currently owe $3,000, your credit utilization rate is 15% ($3,000 / $20,000).
That may seem simple enough, but calculating your overall credit utilization is just the beginning. Most consumers have multiple credit cards and lines of credit available to them, each with their own credit utilization rate. For instance, let’s say you owe that $3,000 on one card that has a $4,000 limit. Your overall credit utilization might be 15%, but it’s actually 75% for that particular card, which is considered high utilization. Although this won’t destroy your credit score, it’s not an ideal situation.
What Is a Good Credit Card Utilization Ratio?
The three major credit bureaus — Experian, Equifax, and TransUnion — gather credit scoring algorithms from either VantageScore or FICO, the two leading credit scoring companies. With either type of credit score (your FICO score is used by more lenders), your credit utilization should ideally be no more than 30%. If you have a higher credit utilization rate, your credit score may suffer as a result.
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If you’re trying to achieve excellent credit score range (above 740), the ideal credit utilization is 1%. This means you carry a minimum balance on your revolving credit accounts compared to your total available credit. In any event, keeping your credit utilization ratio as low as possible — while still demonstrating that you know how to use credit responsibly — is the goal.
How to Improve Your Credit Utilization Ratio
One of the most straightforward ways to raise your credit score is maintaining a lower credit utilization ratio. This shows creditors you have ample access to credit but don’t need to use it all. Using less of your available credit is the most obvious way to accomplish this task, but you may not have the ability to pay down the balances you owe immediately. If that’s the case, here are a few steps you can take to improve the credit utilization ratio.
As previously mentioned, the first strategy is paying off as much as your current balances as possible. Making an extra payment each month will help bring down a high credit utilization rate, and it might be easier on your monthly budget than making a single large payment every 30 days, especially if you get paid biweekly.
Another method is spreading out your credit use among different cards, paying close attention to your credit limits on each. This will help reduce your credit utilization on each individual card, even if it doesn’t necessarily bring down your overall credit utilization ratio. Asking for a credit limit increase on one or two cards can accomplish the same thing.
Keeping older credit accounts open, even if you’re no longer using them, helps keep your overall available credit high and also impact the length of credit history, another factor in your credit score.
You can also open a new credit account to help lower your credit utilization ratio by increasing your total access to credit. Just remember to keep the new card debt below that 30% mark whenever possible, and be wary of opening too many new credit cards in a short period of time. Overall, it’s best to slowly add and maintain credit card accounts over a few years, so you can lengthen the overall age of your accounts on your credit report without an unusual amount of activity.
Your credit utilization ratio can have a big impact on your credit score, so it’s important to know how it is calculated and the steps you can take to improve it over time. Be careful when implementing the strategies above to avoid having a negative influence on the other factors that impact your score.
Overall, working to pay off credit card balances without establishing too many new accounts or closing the old will help improve both your credit utilization ratio and your credit score.