Like it or not, credit scores can play a big role in our financial lives. It will most likely help determine interest rates when borrowing money, and it may even be a factor when applying for a job or an apartment. There are many different credit scoring models, but the FICO Score is by far the most widely used. Approximately 30% of your FICO Score is based on the amounts you owe. Credit utilization is one of the most important factors evaluated in this category!
Our credit scores used to be pretty awful. We did have a bankruptcy after all. For a long time I felt embarrassed, ashamed, guilty, and irresponsible. I didn’t think we were irresponsible people, but I guess we were somewhat irresponsible with our money. We were definitely in over our heads. We’ve worked hard to improve our credit score, so now we actually pay attention to our credit utilization.
How is your utilization ratio calculated?
Your credit utilization ratio is a measure of your credit card balances compared to the credit limits. In other words, it’s how much you currently owe divided by your credit limit. Here’s an example:
|Card 1||Card 2||Total|
Card 1 has a per-card utilization ratio of 40%, and card 2 has a per-card ratio of 60%. The total utilization ratio in this scenario is 50%. Both per-card AND total utilization ratios are considered in determining your FICO Score.
If all the debt in our example was only on one card, the numbers would look quite different.
|Card 1||Card 2||Total|
The total utilization would still be at 50%, but one card would have a 100% utilization while the other card had 0% utilization. It’s not clear how much weight is given to per-card utilization vs total utilization, but it’s just something to keep in mind. It is better for your score to have more cards with smaller ratios than to have one card that is maxxed out.
Why does your utilization ratio matter?
FICO’s research shows that you’re more likely to have trouble making payments if you have high credit utilization. Someone with a low utilization rate is viewed as being more responsible in handling credit.
If you have a history of consistent payments, this can show lenders that you are responsible with credit and may help offset utilization concerns. In some cases, a low credit utilization ratio will have a more positive impact on your FICO Scores than not using any of your available credit at all.
What is your actual utilization ratio?
Would you like to see your actual percentages? Just enter your numbers in the calculator to see your per-card and total utilization ratios. If you don’t like the numbers you see, it might be time to focus on reducing your debt or follow some strategies listed below to improve your ratio.
Your utilization ratio is just a snapshot of your balances at a specific point in time. Your actual ratios and balances maintained by the credit reporting agencies depends on when the credit card companies update your balance information.
Let’s say you have a $4,000 balance (on a $5,000 card) that you plan to pay in full. If the credit card company reports the figures before you have paid it off, that’s an 80% utilization ratio being reported. If you paid off or reduced your balance before the data is reported, your utilization ratio would be better.
The reporting dates vary. You could call your credit card company to find out when they report to the credit bureaus if you want to ensure you pay your balance prior to that date.
How can you improve your utilization ratio?
- Spread spending over multiple cards to keep the per-card ratio lower
- Make multiple payments during the month to keep your balance and ratio lower
- Keep accounts open, even if you do not intend to use them
- Request an increase to your credit limit
- Apply for additional credit cards to increase your overall limit
If you are having trouble with overspending, increasing your credit limits or applying for additional cards may not be the right move for you. The last thing you want to do is get into more debt while trying to improve your credit score!
We significantly improved our total utilization this year. In August, I opened 3 new credit card accounts for the cash back perks on two of the cards and the balance transfer offer on the other. Prior to opening these accounts, our total credit card utilization rate was 32.82%. Just by opening the new accounts, our utilization dropped to 16.77%!
Our per-card utilization isn’t good because we have balance transfers we are working to pay off. The 0% APR is more important to me than my utilization ratio, at least in the short term.
While there is no perfect utilization rate that applies to everyone, many experts recommend keeping your utilization rate below 30% at ALL times. Even if you pay your card in full each month, exceeding 30% utilization at any point in your billing cycle could affect your score. For more information, check out these great articles at NerdWallet and Experian.
What about your debt?
If you are drowning in debt or barely scraping by, you probably don’t care about your utilization ratios at all. I get it. For a long time, I didn’t WANT to know. I knew things were bad, and looking at HOW bad it was only made me feel worse.
However, I’ve also learned that nothing will change until you face it and work through it. Your ratios are just one indicator of how you are doing. You know if you feel out of control, stressed, or broke. The way you feel about your finances probably says more than any number could.
That said, improving your utilization ratio probably also means you are improving your entire financial situation. I don’t think your utilization ratio should be the most important factor in deciding how to attack your debt repayment. It is more important to follow a plan that will get you out of debt in a way that fits your life.
If you are not sure where to start, Undebt.it is the tool that we use for our debt repayment plan. Once you are out of debt, then you can focus on using credit cards in the best way to help your utilization ratio and your credit score.
Improving your utilization ratio can help improve your credit score, so it is worth paying attention to. Keep in mind that you do not need to keep balances on your credit cards to help your credit score. Paying your cards in full each month helps your score too.
To avoid more debt, use your credit cards ONLY when you already have cash to pay for the purchase.
Come back in a few months and use the calculator again to check your utilization progress!