You may have heard of the term “credit utilization ratio” or “credit utilization rate” used when referring to credit scores and finances.
This important metric is used by many credit bureaus to determine your credit score and can have a huge impact on whether you are approved for new loans or not.
But what exactly is your credit utilization ratio and why should you care?
If you are looking to improve your credit score, paying attention to your credit utilization ratio is vital to getting the improvements you’re after. We break down everything you need to know about this number and how you can influence it to your advantage.
What Is Your Credit Utilization Ratio?
Your credit utilization ratio is essentially the difference between how much credit you have access to compared to how much you have actually used.
When you get a credit card, it has a limit of credit applied to it, which equates to how much money you could spend on that card before it would max out and no longer be used. This limit is known as your available credit, and represents how much the lender trusted you to be able to pay back in a reasonable time. How much you actually spend on the card, and subsequently owe to the creditor, is your “utilized credit”. Thus, your credit utilization ratio is your utilized credit divided by the total amount of your available credit.
For example, you might have a credit card with a $1,000 credit limit. You then spend $400 on it. This would leave you with a 40% credit utilization ratio, as $400 divided by $1000 equals 0.4 or 40%. This number will change every time you make a purchase or pay off your credit card, so it is constantly in flux.
What Impacts Your Credit Utilization Ratio?
Your credit utilization ratio is directly affected by the amount you spend and pay off on your lines of revolving credit.
Revolving credit is any form of loan that does not have a specific term length or end date. Things like credit cards and lines of credit are considered revolving, as they are spent and paid each month without a specific date when they will close. This is the only form of credit that impacts your credit utilization ratio, as things like mortgages and car loans factor into your credit score in a different way.
Per card or Total Utilization?
There is also your per-card utilization ratio, which refers specifically to your ratio on each individual card, as opposed to your total overall ratio.
If you had one card with a $1,000 limit which you spent $400 on, and another card with a $2,000 limit, which you spent $400 on, your per-card utilization ratios would be 40% and 20% respectively. Taken together, your total credit utilization ratio would be 30%.
The impact of your per-card compared to your total ratio is not clearly defined, but it is wise to keep an eye on both metrics if you are looking to improve your credit score.
What Is The Ideal Credit Utilization Ratio?
The ideal credit utilization ratio is typically around 30% or less as advised by credit bureaus and financial advisors.
By keeping your ratio below 30%, it demonstrates to potential lenders that, while you have access to plenty of credit, you do not need to use all of it to survive. This shows that you are financially responsible and more likely to make repayments on any new lines of credit you are approved for.
The 30% rule generally applies to your total credit utilization ratio, but it is wise to apply the rule to each of your individual revolving credit accounts as well. If you have one card at 60% but another card with a 0% balance, you will still technically have a 30% utilization ratio, but lenders will still be able to see that you have used a lot on one card, which could be a warning sign to them. Credit bureaus will also treat per-card and total utilization ratios differently, so keeping all your ratios to 30% or less is the smartest move you can make to maximise your credit score.
Payment Timing And Credit Score Improvements
Another element to be aware of when considering your credit utilization ratio and its impacts on your credit score is the timing of your repayments.
Every month, your credit provider will issue you a statement to let you know how much money is owing on the account and when your repayment is due by to avoid a late payment charge. While you won’t be penalised for making your minimum repayment by the due date, what many people do not realise is that your credit provider will generally report your owing balance to the credit bureaus about a week prior to that due date.
This means that even if you pay off your credit card bill in full on the due date, thus bringing your credit utilization ratio down to zero, your credit provider will have sent off your current outstanding balance to the credit bureaus. If you had a particularly big month of spending and your ratio was a little high, this can be reflected in a slight dip in your credit score. All is not lost, however, as the part of your credit score that is impacted by your utilization ratio is updated every month, so if you pay off your credit card bill a few weeks before the due date, you should see your credit score improve in no time.
How To Influence Your Credit Utilization Ratio
Now that we understand what your credit utilization ratio is and how it impacts your credit score, it’s time to look at how we can influence the ratio and use it to improve our credit histories in the long run. There are several relatively simple things you can do to leverage your ratio for better credit, including:
Paying down your revolving credit every month
As mentioned previously, your credit utilization ratio is directly tied to how much money you have spent on your credit cards and lines of credit over the course of a month. By ensuring you pay down your credit card bills every month, ideally to a zero balance, is a guaranteed method of controlling your ratio and keeping it low enough to benefit your credit score. Even if you cannot get it to zero, keeping your overall (and ideally your per-card) ratio as close to 30% as possible will show immediate improvements in your credit score.
Maintaining revolving credit accounts with a zero balance
Over the course of your life, you will likely realise that you are no longer using certain lines of credit and might consider closing them. If your balance is at zero and there aren’t any excessive yearly fees associated with the credit, you might want to consider keeping it open. Having an extra source of total credit that will be factored into your credit utilization ratio will lessen the impact of spending on your regular cards. For example, you might have a credit card with a $1,000 limit that you haven’t used in months and has a zero balance. You might also have your regular credit card with a limit of $2,000 that you spend all the time on. If you spent $1,000 on your regular card, and kept your unused card open, you total credit utilization ratio would be 30%. However, if you were to close that unused card, your ratio would bump up to 50% and likely damage your credit score.
Increase limits on your current credit cards
Another way to influence your credit utilization ratio is by increasing the limits on your current credit cards.
While it might go against all the advice you have heard from your more financially conservative friends, increasing your limits will increase your total available credit which will subsequently lower your ratio. For example, If you have a card with a $1,000 limit and spend $500, your ratio will be 50%. However, if you increase your limit to $2,000, spending $500 would result in a ratio of just 25%. As you can see, if keeping a low credit utilization ratio is your aim, and you can trust yourself with the increase limit, going for a higher amount is a relatively easy way to lower your ratio and increase your score.
Apply for new lines of credit
Similar to the above suggestion, you can manipulate your credit utilization ratio by applying for new lines of credit.
Just like increasing your credit limits on existing cards, applying for new lines of credit will increase your available pool of credit and lower your ratio. Care should be taken when applying for new credit, however, as applying for too many credit cards can negatively impact your score. If you are not approved for a line of credit, you will have taken a hit on your credit score for nothing, so make sure you are reasonably confident you would be approved for a line of credit before you apply.
Should I close my unused credit accounts?
Conventional wisdom would suggest that if you aren’t using something you might as well get rid of it. However, this may not be the wisest decision in terms of your credit score. As mentioned above, keeping unused lines of credit with a zero balance is a good way to control your credit utilization ratio and ensure your spending doesn’t negatively impact your credit score as significantly. If you really do not want to keep this card open, looking for a low rate, low fee credit card or line of credit to open to replace it in a few months is a wise decision to ensure your credit score keeps improving.
Do you have any other tips for how you like to influence your credit utilization ratio? Let us know in the comments below!