What Is Credit Utilization Ratio?
The credit utilization ratio is a metric that shows how much of your available credit you’re using. It’s calculated by dividing the total amount of credit used (including both open and closed accounts) by the amount of available credit. It is basically the amount of debt you have compared to your available credit. This number is more important than it seems, because it can hugely impact your credit score. You can check your credit score for free to ensure you are eligible for the best loans and credit card offers.
What is a Good Credit Utilization Rate?
A good rule of thumb is to keep your total credit card balances below 30 percent of your available credit. A high utilization rate can indicate that you’re using more than 50% of the total amount you have available on all your accounts. A high credit utilization rate can be a red flag. It means you may have trouble paying back your debts and need to make changes in your spending habits or budgeting. If you have a relatively low credit utilization ratio, it’s a good sign that you’re using your available credit wisely and keeping payments on time.
How Does Credit Utilization Affect Credit Score?
Credit utilization is a calculation that shows how much of your available credit you are using. The higher this number is, the more likely you are to be hit with late payments and other fees.
Credit utilization affects your credit score because it’s tied to your credit history. Lenders will view it as a risk when you have too much debt. For instance, if you’re carrying a balance on your credit cards, it could affect your score because it shows that you’re not managing your finances well.
Credit utilization can affect your score in two ways:
- The less you use the better. If you keep your balances low and don’t draw down any more available credit than you need, then your score will benefit from it.
- The higher the ratio, the worse it is for your score. This is because lenders look at all of their information together when calculating your score, so if one part of your credit history is lower than another, then that can affect how good or bad a lender thinks you are overall.
How Can You Calculate Your Credit Utilization Ratio?
While calculating your credit utilization ratio might seem challenging, it’s easier than you think. To calculate your credit utilization ratio, all you have to do is:
- Calculate your total credit limit by checking all your credit cards.
- Once that is done, total out the balances or check your usage among all the credit cards.
- Now divide your total balance with your credit limit and multiply it by 100.
Doing this will give you your credit utilization percentage. Take a look at the formula below to understand it better:
Total Balance x 100
Total Credit Limit
How to Improve Credit Utilization Ratio
Even though the credit utilization ratio is a bad thing, it’s not the end of the world. You can improve your credit utilization ratio by:
- Paying down your debt
- Refinancing your credit card debt with a personal loan
- Asking for a higher credit limit
- Apply for another card
- Leave cards open after you pay them off.
Shiv Nanda is a financial analyst who currently lives in Bangalore (refusing to acknowledge the name change) and works with MoneyTap, India’s first app-based credit-line. Shiv is a true finance geek, and his friends love that. They always rely on him for advice on their investment choices, budgeting skills, personal financial matters and when they want to get a loan. He has made it his life’s mission to help and educate people on various financial topics, so email him your questions at [email protected].