What is a Credit Utilization Ratio?

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One of the downsides to using credit is that it’s easy to get carried away and spend more than your budget allows. It takes self-control to understand that just because you might be able to spend upwards of $10,000 and rack up massive charges doesn’t mean you should.

A factor that keeps borrowers in check is the credit utilization ratio. In this post, we’ll explore what a credit utilization ratio is and how it affects consumers.

Credit Utilization Ratio: An Overview

A credit utilization ratio is a calculation of the amount of revolving credit that you’re currently using.

To calculate this ratio, simply divide the amount of revolving credit that you have open from various lenders, and divide it by the total amount of remaining credit that you have across all your accounts. For example, if you have $100,000 in credit spread out across five different credit cards and you’ve racked up $15,000 in charges, you have a 15 percent credit utilization rate.

Calculating Your Credit Utilization Ratio
Overall Credit Limit Outstanding Credit Utilization Ratio
$100,000 $15,000 15%
$100,000 $25,000 25%
$150,000 $25,000 16.7%

It’s important to remember that credit utilization is variable. It changes depending on your credit balances. If you take on more debt and keep the same credit limits, your credit utilization will increase. At the same time, if you pay down your credit cards or keep a minimum balance and increase your available credit, your utilization rate will drop.

What is Revolving Credit?

The credit utilization ratio only applies to revolving credit — or credit cards and other lines of credit.

This type of debt is revolving because it doesn’t have a fixed end date. The balance you owe carries over or revolves between monthly billing cycles.

Revolving credit is fundamentally different from installment loans like auto loans and home mortgages. You’ve already taken out the money to secure a car or home; revolving credit is available when you need it, assuming you continue to pay what you borrow in a timely manner.

How Credit Utilization Impacts Your Credit Score

Credit card bureaus like Experian and Transunion keep a close watch on your overall credit utilization ratio. They use that information and use that score to make sure you aren’t taking on too much credit card debt and living beyond your means. The rule of thumb is to have a credit utilization ratio of less than 30 percent. But you should really try to keep it even lower than that. Otherwise, your FICO score can plummet.

Keep a close watch on your credit and check it often (you can do this by using a credit monitoring service). If you notice that your score drops, check your utilization rate and notice if you have high balances because that can knock your score down several points.

TIP: You may also be able to increase your credit utilization rate by asking your credit card providers to increase your credit limit. To illustrate, $10,000 in credit card debt against a $50,000 credit limit is a 20 percent utilization rate. With $100,000 in credit, that same debt is only a 10 percent utilization rate.

Additional factors that impact credit scoring

Credit utilization is only one factor that influences your score. Here are some additional factors that affect credit scoring models.

Payment history

To build strong credit, you need to consistently make payments on time over a long period of time. Consistently missing payments can negatively impact your credit and make it harder to access loans and favorable rates — or even secure credit in the first place.

Credit mix

Credit bureaus also want to see that you have a healthy mix of credit. For example, in addition to credit card accounts, this may include personal loans, auto loans, and home loans, among other things. For the best results, focus on building a healthy mix of credit and paying your loans down over time.

Length of credit history

Another important factor that goes into your score is your overall credit history. The longer you’ve been trying to build credit, the better it is for your score. By the time you are 30, you should have at least one or two accounts that have been open for a decade.

Tips for reducing your credit utilization ratio

The good news is that if your score falls due to high utilization, you can easily make up the difference by paying down your accounts.

What you don’t want to do is keep adding more to your balances without making any payments. This is an easy way to fall into problem debt, which can be difficult to get out of and highly damaging to your overall credit score and mental health.

Here are a few things you can do to get your credit utilization below 30 percent.

Pick up a side hustle

Paying down hundreds or thousands of dollars of debt on a fixed salary is next to impossible, especially when you have other bills to pay — like rent and utilities.

Consider starting a side hustle to bring in more income and get our credit utilization ratio back to normal. For example, you could walk dogs, start blogging on the side, or manage social media accounts for local businesses.

Side hustles can be very lucrative and they can provide critical income to support your financial goals.

Keep a budget

It’s also a good idea to keep a budget so you can keep your spending on track. Instead of treating a credit card like a bottomless pit of money, remember that you have limited income and cap your spending so you don’t go overboard.

If you’d like to start keeping a budget, consider using a budgeting app to track your cash flow and allocate your money appropriately.

Take my word for it: Starting a budget is one of the best personal finance decisions you can make. It can protect you from spiraling into problem debt and help you get out if you’re already there.

Maintain a high total credit limit

If you have the discipline to avoid overspending and your credit situation allows for it, consider opening multiple lines of credit. Find the best credit cards on the market and apply for them. You should also consider asking for a credit limit increase from time to time from your current credit card companies.

Then, once you have multiple credit cards, maintain zero balances across all your accounts. This can boost the overall amount of credit that you have while keeping your credit usage low.

One strategy you should consider is locking certain cards you’re not planning to use. This prevents unauthorized individuals from hacking into your account and silently racking up charges. You can always temporarily activate a card if you need to use it.

Frequently Asked Questions

How often should I apply for new credit cards?

There is nothing wrong with applying for credit cards if you can manage to keep spending at a minimum and aligned with your monthly budget. Credit bureaus aren’t going to punish you for having too many accounts open. In fact, having more credit available can boost your credit score.

Just remember that every time you apply for a credit card, the agency is going to perform a hard check on your credit which could knock your score down a few points. That being the case, it’s better to space your cards out over time and work toward establishing a healthy credit line at a steady pace — not overnight.

Why do I need a good credit score?

Many young people are skeptical about opening credit cards. But the truth is that opening credit is necessary for many things.

For example, large-ticket items that require loans — like homes and cars — require credit checks to see if you’re a responsible buyer. If your credit score comes back with several red flags, it could prevent you from getting a loan or result in a loan with unfavorable interest rates.

Make sure to track and monitor your credit score and focus on keeping your utilization rate at a normal level. It’s very easy to lose track of your credit if you’re not careful and end up in a tough situation because of it. Credit debt can set you back years or even decades financially.

Is a high credit card utilization ratio bad?

A high credit card utilization rate can harm your credit and lower your score. Aim for a low utilization rate if possible and always pay down your balances at the end of each month.

I’m in credit card debt. Now what?

If you are in credit card debt and you can’t easily make a payment to get out of it, you need a plan.

Focus on forming a debt reduction strategy by putting yourself on a tight budget and working to improve the situation.

The hard reality is that getting out of debt will not be easy. It’s going to require sacrifice in one form or another — either in large lump-sum payments or steady high monthly payments. Neither option is fun or exciting. But you have to make it a point to get out of debt as quickly as possible. Debt can wreak havoc on your personal finances and it can be very stressful on yourself and your family, too.

You should also spend some time thinking about why you are in debt. It may require taking a look at your spending patterns and adjusting your lifestyle accordingly. If you don’t fix the patterns that cause you to find yourself saddled with debt in the first place, you could just as quickly fall back into the track again in the future.

Should I accept a debt consolidation loan?

If you’re in deep with credit card debt from multiple credit card issuers, you may consider a debt consolidation loan that combines multiple unsecured debts into a single monthly payment.

On one hand, debt consolidation companies promise lower interest rates while making it easier to make one payment instead of several. However, while debt consolidation companies promise the world they often fail to deliver on lower returns. Sometimes you wind up paying more on a monthly basis than you would otherwise.

Another thing to consider is that a consolidation service can extend the amount of time that you’re in debt. You’ll pay more over time in exchange for making lower monthly payments.

Consider your options before opting for debt consolidation and make sure you are comfortable with the offer before signing up for a service.

The Bottom Line

If you’re using credit cards, then you have to pay attention to your total credit utilization. It’s that simple.

Having a low credit utilization rate plays a major part in a healthy overall credit score. If you have high credit utilization, it could have disastrous consequences on your personal finances. If you want to achieve financial freedom, you need to avoid approaching anywhere near your credit card limits.

The good news is that maintaining a healthy ratio doesn’t have to be difficult. Simply keep a budget and make sure your spending stays in line with your monthly cash flow. If you start to spend too much, pay down your balances and get out of debt as quickly as possible.

At the end of the day, managing debt is all about maintaining discipline and having the ability to exercise restraint. If you have trouble paying your credit card balances in full each billing cycle, you should take active measures to change your habits. Otherwise, you will have a hard time keeping a clean credit report.

While your credit utilization ratio is only one of the metrics that influences your credit score, it’s the biggest one. Keep that rate in check and take more control over your financial future.

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