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What Is a Credit Utilization Ratio & How Does It Work?

What Is a Credit Utilization Ratio & How Does It Work?
Jason Steele
Jason SteeleUpdated September 19, 2022
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
Would you loan money to someone who is already deeply in debt? Maybe. Maybe not. But, chances are, you’d prefer to loan money to someone that had little or no debt. Banks and other lenders feel the same way, which is why your credit utilization ratio (a measure of how much debt you currently have) is one of the biggest factors in your credit score.  What exactly is your credit utilization ratio? Simply put, it’s a measure of how much you owe on all your revolving accounts (like credit cards) compared to how much credit you have available. Read on for a closer look at how credit utilization ratios work, how to calculate your ratio, and how to know if your number is good — or could use improvement.

Definition of the Credit Utilization Ratio

A credit utilization ratio is the money you owe on your credit cards relative to the total amount of available credit that you have. This calculation results in a percentage that is used by credit scoring models to help predict the likelihood that a borrower will repay a loan. 

How Credit Utilization Ratio Works

The actual amount of credit card debt you currently have is actually less important than how that number compares to the amount of credit you have access to. For example, if someone has $1,000 in debt, is that a lot? It could be if the person has a modest income and, as a result, has only $1,500 in available credit. This person has used up two-thirds of their available credit and their credit utilization ratio is 66%, which can contribute to a bad credit scoreOn the other hand, if this person has $10,000 of available credit, their credit utilization ratio is just a mere 10%, which can lead to a good credit score

How to Calculate Your Credit Utilization Ratio

A credit utilization ratio is the sum of all your balances, divided by the sum of your cards' credit limits. As complicated as that sounds, it’s fairly easy to calculate. The first step is to gather all of your credit card statements, and then add up all of your outstanding balances. Next, add up all of the credit limits you have on your cards. Now, take the balance total and divide it by the credit limit total. Finally, multiply this number by 100 to find your credit utilization ratio as a percentage amount.For example, if you have one credit card with a $2,000 limit and your current balance is $1,000, your credit utilization ratio, expressed as a percentage, would be 50%.

What Is Revolving Credit?

Revolving credit is a type of credit that is open-ended, such as a credit card or other line of credit (such as a home equity line of credit). When you are approved for revolving credit, you are given a credit limit, which is the maximum amount you can charge to the account. When you make a purchase, your available credit goes down. When you make a payment, your available credit goes back up. Revolving credit accounts are open ended, meaning they don’t have an end date like installment loans (such as mortgages, student loans, or personal loans) do. As long as the account remains open and in good standing, you can continue to use it. 

What Is a Good Credit Utilization Ratio?

While there’s no ideal number, generally, a lower credit utilization ratio number is better than a higher one, since it shows that you’re using your credit responsibly and not overspending. Having a high credit utilization ratio, on the other hand, means that you’ve already borrowed a large percentage of what you’ve been offered. Many credit experts agree that it’s best to keep your credit utilization ratio no higher than 30%. 

Balance Reporting and Credit Utilization

As you use your credit card for purchases, and pay it off, you’re impacting your credit utilization ratio. However, even if you make a big payment and significantly lower your ratio, you won’t likely see any change in your credit scores right away. The reason is that your credit utilization ratio is based on your most recent balance from each of your creditors. Credit card companies typically update balance information with the credit reporting agencies every 30 days, or at the end of your billing cycle. Your credit score gets updated only when creditors provide new information to the credit reporting agencies for your accounts. Also keep in mind that credit card refunds, which also lower your balance and contribute to a lower credit utilization ratio, can take up to a month to get processed.

Opening Credit Cards to Improve Your Credit Utilization Rate: What to Know

Some people think it’s a good idea to open new credit card accounts in order to improve their credit utilization ratio and improve their credit scores, but should you do it? It depends.Opening new credit accounts can lower your credit utilization ratio by increasing the amount of available credit you have. However, this comes with a few caveats. Credit scoring models also look at the number of times a creditor makes a hard credit inquiry (which happens when you apply for a new credit card) within a certain time period. A certain number of inquiries within a certain period of time could negatively impact your scores. Also, your mix of credit is factored into your scores. So, if you have a lot of credit cards (which is revolving credit) compared to installment credit (e.g., mortgages, student loans, auto loans, and personal loans), adding another credit card to the mix may not be ideal. Some people wonder how many credit cards you should own. You should never have more credit cards than you can manage responsibly. If having additional credit cards will give you an increased incentive to spend more and incur more debt, or if you may be overwhelmed by all the payments, then you shouldn’t open up new credit card accounts. However, you may wish to request a larger line of credit from your existing accounts. 

How Closing a Credit Card Can Affect Your Credit Utilization Rate

Closing an existing line of credit can raise your credit utilization ratio for a given amount of debt. However, if you have numerous lines of credit, closing one might not have a significant impact. If, on the other hand, you have just a few, closing one could cause your credit utilization ratio to go up. That’s why some people prefer to keep an unused credit card account open, especially if there is no annual fee. 

How Much Does Credit Utilization Affect Your Credit Score?

Your credit utilization ratio is just one component of your credit score, but it’s an important one. According to Experian, it can impact up to 30% of a credit score, depending on the scoring model being used.

What Can Lower Your Credit Utilization Ratio?

Basic math tells us that there are only two ways to lower a ratio. One is to decrease the numerator, which is the amount of debt. The other way is to increase the denominator, which is the amount of available credit that you’ve been extended.You can decrease the amount of debt that’s being reported by paying off your credit card balances. In fact, you can even pay off all or part of your balances before the statement period closes, in order to have a lower balance reported. To increase your available credit, you can apply for new accounts, or ask your existing accounts to increase your credit line. You can also refrain from closing unused accounts in order to preserve your existing lines of credit. 

The Takeaway

When you’re trying to manage your credit score, it’s important to understand how your credit utilization ratio works. Understanding this key factor, and doing your best to keep it low, can help you build your credit profile. This will give you the opportunity to be approved for a wider variety of credit cards and other loans, at the most favorable rates. If you’re in the market for a new credit card, Lantern by SoFi can help. With our credit card marketplace, it’s easy to compare multiple credit card offers matched to your needs and qualifications all in one place.
Photo credit: iStock/KittiBakai
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About the Author

Jason Steele

Jason Steele

Jason Steele has been writing about credit cards and award travel since 2008. One of the nation's leading experts in this field, he has contributed to dozens of personal finance and travel outlets and has been widely quoted in the mainstream media.
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