Your credit utilization ratio (or credit utilization rate) is how much you owe on all your revolving accounts, such as credit cards, compared with your total available credit. This ratio is expressed as a percentage.
The ratio is calculated by dividing the total balance by the total limit. Because an outstanding balance will never exceed the total limit, this results in a percentage that will always be less than one.
The number reflects how much a consumer uses credit for purchases and other spending activity. The smaller the number, the less credit used, while the larger the number, the more credit is being used.
The credit utilization ratio is calculated by dividing the total outstanding balance by the total credit limit.
If a consumer has three cards with outstanding balances of $500, $600, and $750, the first step is to calculate the total outstanding balance for all three cards. In this case, the total outstanding balance equals $1850 ($500 + $600 + $750 = $1850).
The next step is to calculate the total credit limit. If the limits for the three cards in this equation are $1000, $2000, and $3000, the total credit limit is $6000 ($1000 +$2000 + $3000 = $6000).
The third and final step is to divide the total outstanding credit ($1850) by the total limit ($6000). In this case, the credit utilization ratio equals .31 (1850 ÷ 6000 = .308, which can be rounded up to .31) This can be expressed as .31, 31 percent, 31% or (approximately) one-third.
If the credit utilization ratio is being calculated for only one account, then the first two steps in the example above are unnecessary. There is only one outstanding balance and one limit, so the calculation can begin at the third step of dividing the two, without the need for any addition.
The credit utilization ratio only applies to what is referred to as “revolving credit.” This refers to credit lines and credit cards that have no end date, and the amount owed carries over or “revolves” from month to month. It can be paid off either in part or in full at any time.
The credit utilization ratio does not include installment loans, such as mortgage loans or auto loans, which have defined payback periods and are factored into a consumer’s credit using a different calculation.
The credit utilization ratio is used by consumers to evaluate their own credit. A higher ratio means that the consumer is using a greater share of available credit.
A lower ratio indicates the consumer is using less available credit for purchases.
The credit scoring agencies—TransUnion, Equifax, and Experian—use the credit utilization ratio to help calculate a consumer’s overall credit score.
The credit utilization ratio is weighed heavily by the agencies. It can account for as much as 30% of a consumer’s credit score.
The credit utilization ratio may also be considered by investors or lenders when evaluating the performance of a small business.
A commonly accepted threshold for consumers to consider in evaluating the credit utilization ratio is 30%. In other words, consumers are generally advised to keep the ratio below 30%.
In the example above, the credit utilization ration was 31%, so the consumer in this scenario would be advised to take steps to lower the ratio by the two or more percentage points.
The simplest way to lower a credit utilization ratio is to pay down some of the outstanding balance. A consumer can also request to have the credit limit raised. A third option is to apply for another credit card.
The latter two will have the effect of increasing the total available credit limit, which will lower the ratio once the additional credit is added in.
A credit utilization ratio can be calculated for one card or multiple credit cards combined.
A consumer can also calculate the credit utilization ratio per card.
This involves making a separate calculation for each card individually, instead of adding them up.
A per card credit utilization ratio is an important option for consumers to evaluate how each of multiple cards is being used. If one card is being used more heavily than others, the per card calculation will help the consumer identify this activity.
If all cards are considered collectively, the consumer will not be able to make this distinction.