Credit Utilization Ratio: Definition, Calculating, How To Improve

What Is Credit Utilization Ratio?

The credit utilization ratio is the percentage of a borrower’s total available credit that is currently being utilized. The credit utilization ratio is a component used by credit reporting agencies in calculating a borrower’s credit score.

Lowering the credit utilization ratio can help a borrower improve their credit score. One thing you should not do if you are trying to improve your credit score is closing a credit card. It is better for your credit utilization ratio to have a low ratio than a closed card.

Key Takeaways

  • A person’s credit utilization ratio will go up and down with payments and purchases.
  • Credit utilization is one factor in how credit bureaus calculate a credit score for a borrower. 
  • It is advised that borrowers pay attention to their credit utilization ratio as a high ratio can reflect poorly on their credit score.
  • You can find credit utilization calculators online, and if you sign up for a credit monitoring service, you will be able to see your ratio with the report.
  • It's not bad to close a credit card, but you can do more for your credit score by paying your card off and keeping it open.

How Credit Utilization Ratio Works

The credit utilization ratio is typically focused primarily on a borrower’s revolving credit. It is a calculation that represents the total debt a borrower is utilizing compared to the full revolving credit that they have been approved for by credit issuers. When managing credit balances, you should also know your current debt to income ratio. This ratio considers both revolving and non-revolving credit, and it is another factor that is regarded when submitting a credit application.

While revolving credit utilization (it goes up and down) is fairly normal, it is important to always keep it below 30% if possible.

How to Calculate a Credit Utilization Ratio

To calculate your credit utilization ratio, you need to pull together all of your credit cards. First, add up all the outstanding balances, then add up the credit limits. Take the total balances, divide them by the total credit limit, and then multiply by 100 to find your credit utilization ratio as a percentage amount.

It is fairly straightforward to calculate your credit utilization ratio. Still, there are plenty of credit utilization calculators online. If you sign up for weekly or monthly credit updates, they will often provide your credit utilization ratio as part of the report.

Example of Credit Utilization Ratio

Below is an example of how a credit utilization ratio is calculated. Say a borrower has three credit cards with different revolving credit limits.

  • Card 1: Credit line $5,000, balance $1,000
  • Card 2: Credit line $10,000, balance $2,500
  • Card 3: Credit line $8,000, balance $4,000

The total revolving credit across all three cards is $5,000 + $10,000 + $8,000 = $23,000. The total credit used is $1,000 + $2,500 + $4,000 = $7,500. Therefore, the credit utilization ratio is $7,500 divided by $23,000, or 32.6%.

How Credit Utilization Impacts Borrowers

A borrower’s credit utilization ratio will vary over time as borrowers make purchases and payments. The total outstanding balance due on a revolving credit account is reported to credit agencies at various times throughout the month.

The timeframe used by lenders for reporting credit balances to an agency can affect a borrower’s credit utilization levels. Therefore, borrowers seeking to decrease their credit utilization must have patience and expect that it may take two to three credit statement cycles for credit utilization levels to drop when debt is being paid down.

Some lenders report to credit reporting agencies at the time a statement is issued to a borrower while others choose to report on a designated day of each month.

Special Considerations

Shifting credit card balances from an existing card to another will not change the credit utilization ratio, as it looks at the total amount of debt outstanding divided by your total credit card limits. However, transferring balances to lower interest credit cards could be beneficial in the long term since lower interest accumulation can keep balances down.

Closing a credit card account that you no longer use can hurt your credit score by reducing your total available credit. Thus, if you continue to charge the same amount or carry the same balance on your remaining accounts, your credit utilization ratio will increase, and your score may decrease.

Inversely, adding a new credit card will help to lower your credit utilization ratio. However, while new cards can benefit credit utilization, they may adversely affect your credit score through increased inquiries and lower average account longevity.

What Is a Good Credit Utilization Ratio?

According to Experian, one of the three major credit monitoring bureaus, a good credit utilization ratio should be kept under 30%. So, if you have $15,000 in credit, your balance shouldn't exceed $4,500.

How Much Does Credit Utilization Affect Your Credit Score?

Credit utilization ratios affect your credit score, as it represents 30% of how creditors rank your credit. If you have high credit utilization, your score can take a hit.

Is It Good to Have 0 Credit Utilization?

It is not necessarily good to have 0 credit utilization. It probably won't hurt your credit score, but it may not help it because creditors want to see that you can manage credit and pay off your credit card debt. For that reason, a low credit utilization may be better for your credit score than a 0 credit utilization.

How Can I Improve My Credit Utilization?

If you want to improve your credit utilization, first pay down your debts to at least under the 30% mark. Other ways include utilizing more credit by asking for a higher limit or opening a new card, or you can keep a card with the balance fully paid open but not use it. However, the best way to improve your credit utilization is to pay off your debt on time.