What Is Your Credit Utilization Rate?
Credit bureaus use a variety of factors to determine an individual's credit score. One of the most important factors they take into consideration is the credit utilization rate, sometimes referred to as credit utilization ratio.
Keep reading to take a closer look at what the utilization ratio tracks, how it is calculated, and how lenders evaluate the different utilization rates.
Revolving credit refers to any debt that does not have a predetermined end date. The most common examples are credit cards, lines of credit, and HELOCs. These types of loans allow the borrower to draw as much or as little from the credit limit up to the overall limit.
Each month the borrower will be required to make a minimum payment based on the amount drawn and, as previously stated, there is no set payback date. This is in contrast to single installment loans that must be paid back in full by a specified date.
One’s utilization ratio is determined entirely by their revolving lines of credit. Personal loans, mortgages, and car loans are not considered when calculating an individual's ratio.
Total Utilization Vs. Per-Card
When a credit bureau or lender is evaluating an individual's utilization rate, they are typically looking at the totality of their revolving credit accounts. For example, if one has a revolving line of credit and multiple credit cards, they will take the combined ratio.
This said, the credit utilization of individual cards can also be considered. This is particularly important when a borrower is asking for a credit increase. If their utilization rate is high, say above 75%, they will be unlikely to be approved for their desired increase. Likewise, a utilization rate of 35% or lower will greatly increase one’s chances of being approved for a limit increase.
What Is A Good Rate?
Many people ask the question “what is the best credit utilization ratio”. Although there are conditions such as too high and too low for credit utilization, in the long term, the best ratio is 0 because it means that the person in question will not be paying anything in interest payments.
In reality, this is not reasonable for most individuals and the general rule of thumb is that people should try to keep their utilization below 30 - 35%. A low ratio shows lenders and credit bureaus that the individual in question is generally responsible with how they manage their debt. High rates, such as those of 70% or over, may indicate that the person has trouble exercising responsible credit use and poses a greater level of default, thus leading to higher interest rates.
How To Calculate
One’s credit utilization ratio is a percentage expression of how much of their extended credit they have used. Because of this, it is a fairly straightforward calculation to complete. Simply divide the total used credit by the total available credit.
For example, consider an individual with $10,000 in revolving credit, of which they have used $2,900. In this case 2,900/10,000 = 0.29. Multiply the result by 100 to receive the answer as a percentage.
In this example, the person in question would have a 29% credit utilization ratio, which is well within the parameters of a good ratio.
How To Manage Your Credit Utilization Rate?
Because of the large impact the ratio has on a credit score, it is important to manage it accordingly. A high utilization rate can result in one being denied for a loan or credit limit increase and may leave borrowers in a tough situation should they need fast access to cash in case of an emergency.
- Always Monitor Balances: It is easy to let credit card balances get out of control when one is not monitoring them. Consumers should be checking every week at least so they know exactly how much they are carrying on their cards or line of credit
- Make Large Payments: Making large payments towards accounts that have gone over one's desired credit utilization rate is the best way to get balances under control
- Pay Off Highest Interest Bearing Accounts First: Accounts that carry high-interest rates are difficult to pay down, especially if only the minimum payment is being made. Any account that carries a high utilization rate and a high-interest rate should be tended to first
Opening New Credit Cards To Improve Your Rate
One of the most effective ways to improve one’s utilization rate is by opening up new credit accounts, the easiest of which is credit cards. When an individual takes on a new credit card they increase their total amount of available credit, thus decreasing their credit utilization ratio.
This only works if the cardholder is disciplined enough to not spend their available credit. If they do, they will be increasing their ratio, thus lowering their credit score and putting themselves in a worse financial position.
Closing Credit Cards Affects Your Rate
When one closes an open credit card they are decreasing their utilization ratio because they are decreasing their overall amount of available credit. This can significantly harm one’s credit score and is advised against. Those who are closing accounts due to unnecessary annual fees on certain cards may be better to consider a credit card downgrade instead.
The credit utilization ratio is one of the most important factors used to calculate a credit score. Failure to maintain a rate of 35% or less can lower one’s credit score and result in the rejection of their loan applications.