What Is a Good Credit Utilization Ratio?
Credit utilization is the total amount of your established credit limits that you are using. Whenever you make a purchase using a credit card or borrow against a credit line, your utilization goes up, and your available credit decreases.
The balance between the amount you owe and the amount of credit you have free is called your credit utilization ratio (CUR). CUR signifies your company’s fiscal strength to potential lenders and business partners. Experts generally agree that it is better to keep your balance below 30%; however, lower is better.
Why CUR Being Too High and Too Low Is Bad for Business
If your CUR is too high, it may mean you are “maxed out” on your cards and lack the means to cover your expenses. This overleveraging is a red flag to creditors and will cause your credit score to drop.
However, it is also possible to go too low with your CUR. When it reaches zero, this could be another signal of fiscal mismanagement. It means you are not using any of your available credit and probably not making the most of your opportunities or making smart business decisions.
So what is a good credit utilization ratio? Is there an ideal number for which you should strive?
What Is the Ideal Credit Utilization Level?
So we know that a ratio of over 30% is too high, while 0% is too low.
Until you reach zero, lower ratios will continue to translate into higher credit scores. Therefore, a 30% utilization ratio is good, 20% is better, and under 10% is ideal. A good rule of thumb is to aim for single digits since consumers with the most substantial credit scores have an average credit utilization ratio of only 7%.
How to Calculate Your Credit Utilization Ratio
Rather than reporting your credit card debt as a dollar figure, a credit utilization ratio is expressed as a percentage. This number is calculated by dividing the amount that you owe on your credit accounts by your overall credit limit on these same accounts.
Assume you have a credit card with a spending limit of $20,000 and a current balance of $5,000. Your credit utilization ratio for this card is 25% (5,000 / 20,000 = 0.25).
If you have multiple credit accounts, be sure to add all of them together when making your calculation.
- Card #1 — $4,000 balance and $10,000 limit
- Card #2 — $2,000 balance and $10,000 limit
- Line of credit — $0 balance and $10,000 limit
- Total of all accounts — $6,000 balance and $30,000 limit
- $6,000 / $30,000 = 25% CUR
What the Ratio Means for Your Credit Score
As mentioned above, potential creditors can deduce a lot about your business’s financial health by looking at how much available credit is being used. For this reason, credit bureaus place a lot of weight on your credit utilization ratio in the credit scoring process.
There are multiple credit scoring models in use today; however, one of the most prominent is the FICO score. This number ranges between 300 and 850 and is used as a summary of your credit report. FICO uses the following system to calculate your number:
- 35%: Payment history — Whether or not you pay your debts on time is the most crucial component in your score.
- 30%: Amounts owed — This is where your CUR comes into play, accounting for nearly one-third of your score.
- 15%: Length of credit history — The more credit history you have, the higher your score.
- 10%: Credit mix — A balanced blend of revolving and installment accounts is better than only having one type of account.
- 10%: New credit — Having too many new accounts indicates financial instability, which will trigger a drop in your credit score.
Now that you know how vital credit utilization is to your overall score let’s explore tips for improving your creditworthiness by getting your ratio in the ideal range.
How to Achieve a Good Credit Card Utilization Ratio
What can you do if your debt loads are pushing these calculations over the max? What is the best strategy to improve and maintain a good ratio? Here are some steps you can take:
- Pay down your balances — This is the most obvious way to influence your ratio calculations. Make it a priority to reduce how much you owe by paying more than the minimum due each month.
- Pay cash instead of charging it — If your ratio is already near or over the 30% limit, try to avoid using your credit cards for new purchases.
- Pay off your balance each month — Once your card is zeroed out, try to only use it for purchases you can pay for each month. Credit should not be used as a long-term loan but rather as a convenient, short-term resource.
- Keep revolving credit accounts open — If you pay off a card and don’t plan to use it again, you may think closing the account will help your credit score. It may surprise you to learn that exactly the opposite is true. When you close these accounts, your available credit limit goes down, and your CUR goes up.
- Keep using your cards — Try not to let your utilization disappear altogether. Use your cards responsibly, making small purchases that you pay off each month to maximize their impact on your credit score.
- Request higher credit limits — It may not occur to you to ask your card issuer for a credit limit increase if you don’t need it. However, raising your limit while paying off the balance is an effective way to widen the gap between these two numbers and improve your ratio.
Don’t get discouraged if your scores fail to register an immediate bump after implementing these steps. It often takes time to get your ratios into the ideal range. And even then, it can be another month before card issuers report your new lower balances to the credit bureaus.
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