Learn the answers to what a credit utilization ratio is and how to calculate it so you can better understand your credit usage.
Credit is a type of money that is available to borrow and repay. It’s a great way to have extra funds for the things you need or provide an easier payment plan for larger purchases. Credit is a convenient and flexible payment option that can also help you build a good credit score as you use it responsibly.
Understanding the personal finance concept of credit utilization ratios is essential to know if you are using credit responsibly or not.
What is Credit Utilization?
A person’s credit utilization refers to how much of your available credit you’re using and how you’re using it.
The important thing is knowing how to use credit in a smart and responsible way so you can get the most out of it. Understanding your credit utilization ratio can also help you analyze how you use credit. A high ratio could hurt your credit score while a low ratio could increase your score.
What is a Credit Utilization Ratio?
A credit utilization ratio is a measurement that compares how much credit you are using over your total credit limit.
Your credit limit refers to the total amount of money you have available to borrow from revolving credit sources like credit cards.
This measurement can help credit users analyze how much credit they borrow and how they are using it. This is important to better understand how you’re using your credit and determine if you’re using it in the best way possible.
This measurement also helps credit bureaus analyze your credit usage. This then factors into how major credit bureaus determine your credit score and how lenders determine how you use credit and loans.
How to Calculate Credit Utilization Ratio
The credit utilization ratio is a simple calculation that takes your total outstanding credit balance and divides it by your total credit limit, then you’ll take that number and multiply it by 100 to get your final rate as a percentage.
Credit Utilization Rate Formula
Follow this formula to calculate your credit utilization rate shown as a percentage.
(Total Outstanding Balances / Total Credit Limit) x 100 = Credit Utilization Ratio
Let’s outline an example to show how this formula works. For example, if you have a credit card limit of $20,000 that means you have a total of $20,000 available to spend on that credit card. This number is your total credit limit.
If you spend $5,000 of that total available credit, or total credit limit, then this number is your total outstanding balance. Calculate the credit utilization rate of this example with the following formula:
(5,000 / 20,000) x 100 = 25%
In this example, the person’s credit utilization rate is 25% meaning that they have used 25% of their available credit. You can do this for each line of credit you have available or you can total all of your lines of credit together to get a total rate for all the credit you have available.
30% Credit Utilization Rate Rule
Everyone’s credit usage rate is going to be different, but there are recommendations to work toward like the credit card 30 rule. The answer to what is a good credit utilization rate is to follow this rule and keep your rate to 30% or lower.
This is a great number to look to if you want to check if you are using too much credit. If your rate is over 30% then it might be an indicator that you need to pay down some credit card debts to lower that percentage and improve your credit score.
Another way to decrease your ratio is to raise your credit card limit. By increasing how much unused credit you have available, you also decrease the percentage of credit you’re using, lowering this score.
How Much Credit Should I Have?
The key to how much credit you should have is that it doesn’t necessarily matter how much available credit you have or how many credit accounts you have open. In fact, having more credit accounts and more available credit can potentially increase your credit score.
The problem lies in how that credit is used and how much of that available credit you currently have pending repayment. Many financial experts recommend you have at least 1 credit account, but no more than you are able to handle responsibly.
How Much Of My Credit Card Should I Use?
In general, how much credit you have available doesn’t affect your credit score. It’s how much of that credit you have used and your utilization ratio that starts to impact your credit score for better or worse.
It’s commonly recommended that you adhere to the 30% rule for credit usage. This rule says you should use less than 30% of your available credit.
Why Does Higher Credit Utilization Decrease Your Credit Score?
There are many variables that factor into someone’s credit score. Your credit utilization ratio factors into these variables as well, making this something you want to monitor.
For example, the higher your credit utilization ratio is the more this negatively impacts your credit score. If your rate is over 30% then your credit score begins to enter the Fair to Very Poor range.
Does Credit Utilization Matter If You Pay In Full?
A smart practice for credit cards or any type of revolving credit is to pay your outstanding balance in full each month. This means you always pay off everything you owe on a credit card at the same time every month.
Credit card balances are usually reported to credit bureaus once a month on the billing cycle date. These reports will inform the credit bureaus of your credit usage. Whether paying in full helped keep your ratio down or not will depend on when you paid in full and when that report was sent.
For example, if you paid in full after the monthly report was sent, then it wouldn’t matter that you paid in full because the outstanding balance you did have was already reported to the credit bureau.
Paying in full before the billing cycle date is a good way to try and keep your outstanding balance low or at zero before that monthly report is sent.
How to Use a Credit Utilization Chart
Creating a credit utilization chart for yourself can help you see overall how you use credit.
Step 1: Start by creating a table in a notebook or in a spreadsheet that lists your different credit accounts.
Step 2: Then outline your outstanding balance on each account and the total credit limit available on each account.
Step 3: Use these numbers to calculate your total outstanding credit balance, your total available credit limit, your credit utilization rate for each credit account, and your total credit utilization rate for all credit accounts.
Now you can analyze your credit usage in detail and make sure your credit usage percentages are all under 30%.
Credit Utilization Chart Worksheet
*Always consult with a qualified financial advisor who can assess your unique financial situation and provide appropriate recommendations for personalized financial guidance.