Rounding it up
Credit utilization is a measure of how much revolving credit you’re using compared to the amount of revolving credit you have available with all of your credit cards
Most of the major credit reporting bureaus use your credit utilization ratio when calculating your credit score.
A credit utilization ratio below 30% is generally considered to be a good sign to lenders, so it can help you secure better loans and interest rates.
The best ways to improve your credit utilization ratio are by paying off any outstanding debt, limiting your spending on credit cards, and requesting credit line increases.
If you’ve ever checked your credit score, you’ve probably seen the words “credit utilization” pop up on the screen.
But what is credit utilization and why is it important?
Credit utilization is basically a measure of how much of your available credit you use at any given time. It’s a simple percentage score that gives lenders an idea of how you handle your available credit. A low credit utilization ratio can improve your credit score while a high credit utilization ratio can make it harder to secure favourable rates on a loan.
We know how confusing all this credit score talk can be, so we’ve put together this quick guide to all things credit utilization. Up next, we’ll dive deeper into what this metric actually means and we’ll give you some top tips for improving your credit utilization ratio in the future.
What is Credit Utilization?
Credit utilization is a metric, expressed as a percentage, that quantifies how much of your available revolving credit you’re using at any given time. Or, put another way, your credit utilization is a measure of how much money you owe to lenders compared to your total credit limit.
For example, someone with $1,000 in available credit and a balance of $250 would have a utilization ratio of 25%. Meanwhile, someone with $10,000 in available credit and a balance of $1,000 would have a utilization ratio of 10%.
The idea here is that credit utilization can be used as a quick way to assess how much someone spends compared to the limits on their credit cards. Since this metric is expressed as a percentage, we can use it to compare the spending habits of people with different income levels and available credit limits.
How to Calculate Credit Utilization
The above examples may have given you a good idea of how to work out credit utilization, but we’ll take a closer look at what’s involved in calculating this metric.
Basically, your credit utilization ratio is calculated by dividing your current credit balance by your total available credit. So, if you have a balance of $10,000 and a credit limit of $100,000, you would divide $10,000 by $100,000 and get a result of 10%.
But keep in mind that you should calculate your credit utilization ratio for the outstanding balances and limits on all of your forms of revolving credit (i.e., all your credit cards). This would give you your total utilization ratio.
There are certain instances where you might want to calculate the credit utilization on just one of your cards. However, most lenders look at the utilization of all of your cards—not just one.
That said, maxing out one of your cards and leaving the others untouched isn’t necessarily a positive thing in the eyes of many banks. So, if you use one of your credit cards more heavily than others, you might want to calculate a per-card utilization ratio, too.
One final note on calculating credit utilization ratios: When you determine your utilization, you should only include lines of revolving credit, not loans that you pay off in installments, like a mortgage. So, include all of your credit cards and your student lines of credit, but not your car loan.
Why is Credit Utilization Important?
Credit utilization is a relatively straightforward concept, but why is it something that any of us should even care about?
Well, it all boils down to the fact that most credit reporting bureaus care about credit utilization. So your utilization ratio can impact your ability to get a loan, to open a new credit card, to get a good interest rate on your mortgage refinancing application, or rent an apartment in a tight housing market.
To be fair, credit bureaus like Equifax and Transunion, don’t tell us exactly how they use credit utilization ratios to calculate your credit score, but we know that they do take your utilization ratio into account when creating that 3-digit number that can have a huge impact on your financial life.
Therefore, having a good utilization ratio can improve your credit score while having a poor utilization ratio can cause your score to plummet over the long term.
What is a Good Credit Utilization Ratio?
At this point, you might be wondering what lenders consider a “good credit utilization ratio.”
Every bank and creditor has a different idea of what “good” means with respect to credit utilization. However, the standard rule, and what you’ll hear most financial coaches tell you, is that you should keep your credit utilization ratio below 30% whenever possible. If you can get your ratio below 20% or even 10%, that’s even better.
The idea is that the lower your credit utilization ratio, the less likely you are to spend beyond your means.
This isn’t an entirely accurate metric, however, as some people may live well within their means and have a high credit utilization ratio simply because they don’t have many credit cards with high limits. Alternatively, someone with many credit cards and a high credit limit may still spend beyond their means but have a low utilization ratio.
Despite the inherent issues involved with calculating credit utilization, it can have a big impact on your credit score. Therefore, trying to keep your utilization ratio below 30% whenever possible is a solid financial move.
How to Improve Your Credit Utilization Ratio
All this talk of credit scores may have you wondering what you can do to improve your credit utilization ratio and, subsequently, your credit score. To help you out, here are 4 steps you can take to help your credit score change for the better.
1. Pay Down Your Debt
The very first thing you can do to help your credit utilization ratio is to pay down your debt. This is certainly easier said than done, but it’s important to note that paying off debt is going to have the biggest positive impact on your financial life in the long run.
Since your credit card debt will continue to negatively affect your utilization ratio until you pay it off, eliminating your outstanding balances can do wonders for your credit score.
Of course, not everyone has the ability to pay their debts off in one fell swoop. So, don’t get discouraged.
Create a debt repayment plan where you put a little bit toward repaying your balances each month. Use the interest you earn and all of the cash back you collect on your KOHO saving and spending accounts to chip away at your debt. Once you do, make a plan to repay your cards off in full each month. Your future self will thank you.
2. Limit Your Credit Card Spending
There’s nothing inherently wrong with making purchases with a credit card, especially if you pay your card off in full every month and you’re spending within your means.
However, even someone that spends within their means and pays their monthly balance can end up with an unnecessarily high credit utilization ratio. This is particularly true if you have low limits on your credit cards, as even a little bit of spending could push you over the 30% utilization threshold.
In these situations, it’s usually best to limit your credit card spending whenever possible. You can certainly use your card, but try to keep your spending under 30% of your credit limit. Once you get close to this threshold, consider switching to your KOHO prepaid Mastercard or another payment method to avoid racking up a larger balance on your credit cards.
3. Request a Credit Line Increase
If you don’t have credit card debt and you’re confident that you’re already spending within your means, requesting a credit line increase just might be a solid plan of action.
Most credit card companies allow you to apply for a credit line increase at any time simply by clicking a button in your online banking dashboard. You’ll usually have to provide updated income information so that your card provider can decide whether they want to give you a higher limit. If you’re approved, your new limit will usually go into effect immediately.
Credit line increases can be a quick and easy way to lower your utilization ratio and improve your credit score. However, there are two potential downsides to doing so.
First, in rare situations, creditors may run a hard credit check on you before they approve you for a limit increase. This normally isn’t the case, but it’s annoying when it happens. When this occurs, your credit score will generally drop a few points for at least 6 months to 1 year.
Second, if you apply for a credit line increase, you need to be confident that you won’t spend beyond your means. The idea here is that you are increasing your limit but keeping your spending at its current levels. Otherwise, you’ll end up increasing your utilization ratio anyway. Not good.
4. Open a New Credit Card
The fourth and final option for improving your credit utilization is to open a new credit card. Doing so has a similar effect to requesting a credit line increase as it increases the amount of credit you have available.
But, this method should be used with caution. If you don’t have debt and you already repay your bills in full every month, then opening a new card for rewards or travel perks might be a good move.
However, if you’re struggling with credit card debt, opening a new card can make things a whole lot worse. Plus, opening a new card will temporarily drop your credit score, so it’s not a good solution if you’re looking to take out a big loan in the coming months.
Opening a new credit card can help you long-term, but it’s not something you should rush into haphazardly.
The Impact of Credit Utilization Ratios
Your credit utilization ratio can have a major impact on your financial well-being, particularly with respect to your credit score. It’s an important metric that creditors use when deciding whether to loan you money and on what terms.
There are steps you can take to improve your utilization ratio, but keeping your debt and spending in check are the best practices. Remember that it takes time to improve your score, so patience and persistence are key.
Gaby Pilson is a writer, educator, travel guide, and lover of all things personal finance. She’s passionate about helping people feel empowered to take control of their financial lives by making investing, budgeting, and money-saving resources accessible to everyone.