Your credit score is an important part of your financial health. Among many other benefits, a good credit score unlocks many savings and benefits, including access to loans and credit cards with the most favorable terms. Based on the FICO scoring model, five factors affect your credit score. As you can guess, payment history is the most important factor, accounting for 35 percent of your score. The next most important factor is your credit utilization ratio, which accounts for 30 percent. But what exactly does this seemingly complicated term mean? In this post, we’ll answer just that.
What is Credit Utilization Ratio?
Your credit utilization ratio is a measure of how much debt you currently have on your credit cards. In mathematical terms, it is the ratio of your total debt to the total revolving credit that has been approved by your credit issuers, typically expressed as a percentage. For instance, if your credit utilization ratio is 27 percent, it means that you are using 27 percent of the credit available to you. In concrete terms, if you have a $10,000 credit limit, then you currently have a $2,700 balance.
How Credit Utilization Ratio is Calculated
All you need to know to calculate your credit utilization ratio are your credit card limits and credit card balances. This information can be gotten from your most recent credit card statements, your online account, or by contacting your credit card company. Once you have this information, simply use this formula:
Credit Utilization Ratio = Credit Card Debt ÷ Credit Card Limits.
Credit utilization may be calculated on a card-to-card basis but is more commonly calculated across all your credit cards to give an overall credit utilization ratio.
Let’s say you have three credit cards with the following breakdown:
- Card 1: Credit line: $10,000, balance $2,000
- Card 2: Credit line: $12,000, balance $3,000
- Card 3: Credit line: $5,000, balance $2,000
On a card-by-card basis, your credit utilization on card 1 will be 20% (2,000 ÷ 10,000). Using the same logic your CUR on card 2 will be 25%, while that on card 3 will be 40%.
To calculate your overall credit utilization, you first have to sum up your total credit line and your total debt. In this example, your total credit line is $27,000, while your total balance is $7,000. Your overall credit utilization becomes 7,000 ÷ 27,000 = 25.9%.
What Credit Utilization Ratio is Good?
Some credit experts advise that you keep your credit utilization ratio below 30% to maintain a good credit score. This applies to both your individual credit cards and your overall credit utilization ratio. Doing so ensures you’ll be viewed favorable irrespective of the method your credit company uses to determine your credit utilization ratio.
Any score above 30 percent can decrease your credit score. And as you already know, a lower credit score makes lenders wary of giving out a loan because of the fear of your ability to repay.
By extension, you might believe that a credit utilization ratio of 0% is ideal. However, this is not the case. A CUR of 0% means you’re not using your credit cards, so you won’t get all the credit score points available for that. While having 0% CUR is surely better than a high CUR, keeping your CUR in the single digits is ideal.
How to Improve Your Credit Utilization Ratio
Lowering your credit utilization ratio is one of the easiest and most effective ways to boost your credit score. Here are four main ways to accomplish that.
- Clear off your balance
Reduce your credit card balance by paying more than the minimum each month. These small extra payments will reduce your debt, and that, in turn, will decrease your CUR.
- Refinance credit card debt with a personal loan.
This can be accomplished in multiple ways, but the most common is to consolidate multiple credit card balances with a personal loan, typically one with a lower interest rate. This helps you to pay more into clearing off your principal. Furthermore, do not close your credit cards after transferring your balance to the personal loan because this will reduce your credit limit, and it may cause an increase in CUR. Instead, by keeping your credit cards open, your CUR decreases. However, make sure you do not use up your balances again unless you’ll end up in more debt and a worse score.
- Ask for a higher credit limit.
It’s a no-brainer that provided you keep your credit debt constant, increasing your credit limit will decrease your credit utilization ratio. Luckily, according to a recent survey by CreditCards.com, 89% of people who ask for a higher credit limit get one.
- Apply for another card
Applying for a new card increases your total credit limit. However, this strategy must be used with caution as it requires great financial restraint. Using up your credit limit on the new card will only put you in more debt, wreak your financial health, and cause a ding in your credit score.
Because your credit utilization ratio is a major factor in your credit score, do well to keep it as low as possible. Doing so will help to boost your credit score, making it easier to secure new loans with favorable terms.
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