A credit utilization rate, which is also sometimes referred to as a credit utilization ratio, is your credit balance compared against your credit limit. Another way of putting it would be to describe it as the amount you currently owe divided by your overall credit limit. Lenders generally consider credit utilization to be a high importance item, often second only to your payment history when it comes to improving your credit score [1].
Having a high credit utilization rate can negatively impact many areas in your financial life. Not only is high credit utilization a potential burden dragging down your credit score, but it could also come into play when applying for a mortgage, credit card, or another kind of loan application. Conversely, having a good credit utilization rate can not only help you secure a better position with lenders, but they can also help lower the interest rate you may end up paying as well.
What is a Good Credit Utilization Rate?
The lower your credit utilization rate, the better. Most ideal would be a credit utilization rate of 0, as this would mean you have no debt compared to your credit limit. That being said, there is some wiggle room here and it is generally recommended that you try to keep your credit score below 30%[2]. Using more than 50% of your total credit available is seen by lenders particularly poorly and will negatively impact your credit score.
How to Improve Your Credit Utilization Rate
If your credit utilization rate is higher than that 30% threshold, all is not lost. Your credit utilization ratio is calculated exclusively using your revolving credit (i.e. your credit cards and other lines of credit). Revolving credit is so named because it doesn’t have a set end with the amount owed carrying over, or revolving, to the following month [3]. Since your credit score is generally updated on approximately a monthly basis, this gives you a monthly cycle to try and lower your credit utilization rate. There are two ways for you to help lower your utilization:
- Paying down your balances
- Increasing your credit limit
While paying down your balances may seem self-explanatory, for many increasing your credit limit may be counter-intuitive for helping to get a good credit utilization rate and, by extension, a better credit score. In reality though, as long as you don’t end up spending more as a result of your higher credit limit, increasing the amount you can borrow against can be one of the quickest and most effective ways to lower your credit utilization rate fast.
EXAMPLE: If you have a credit limit of $10,000, and a balance of $4,000, your credit utilization rate would be 40%. You would need to pay down your balance by at least $1,000 or increase your credit limit by around $3,500 to be at or below the ideal 30% threshold.
For many, knowing what is a good credit utilization rate and how to get there can seem a daunting task; however, there are a few steps you can take in the right direction to set you on your path. Paying down balances, managing and controlling adding to your debt, and increasing your credit limit can all be incredible tools to lowering your credit utilization rate and helping you take steps towards financial independence.
References:
[1] TransUnion. “How Credit Scoring Works”. https://www.transunion.com/blog/credit-advice/how-credit-scoring-works-transunion. Accessed December 19th, 2019.
[2] CreditKarma. “Credit Card Utilization and Your Credit Scores”. https://www.creditkarma.com/credit-cards/i/credit-card-utilization-and-your-credit-score/. Accessed December 19th, 2019.
nb0169715148630431264542154392416308527375. Accessed December 19th, 2019.