Optimize Your Credit Utilization to Boost Your Credit Score

What Is Credit Utilization Ratio?

The credit utilization ratio shows the percentage of your available credit that's in use. The credit utilization ratio is a component used by credit reporting agencies in calculating a borrower’s credit score.

Reducing your credit utilization ratio can boost your credit score. To raise your credit score, keep your credit cards open. A low utilization ratio is better for your credit score than closing a card.

Improving your credit utilization ratio can result in favorable lender perceptions and improved financial outcomes.

How Credit Utilization Impacts Your Financial Health  

The credit utilization ratio mainly focuses on revolving credit. It is a calculation that represents the total debt a borrower is utilizing compared to the full revolving credit that they have been approved for by credit issuers.

Your current debt-to-income ratio is a key metric that affects your credit score, which in turn affects your ability to get credit. This ratio factors in both revolving and non-revolving credit. Aim to keep the use of your revolving credit below 30% to maintain a higher credit score.

How to Calculate Your Credit Utilization Ratio

Follow four simple steps to calculate your credit utilization ratio.

1. Add up all your credit accounts' outstanding balances.
2. Add up the credit limits of these accounts.
3. Divide your total balances by your total credit limit.
4. Multiply the resulting number by 100 to obtain your credit utilization percentage.

Example of Credit Utilization Ratio

Below is an example of how a credit utilization ratio is calculated. Say a borrower has three credit cards with different revolving credit limits.

• Card 1: Credit line $5,000, balance $1,000
• Card 2: Credit line $10,000, balance $2,500
• Card 3: Credit line $8,000, balance $4,000

The total revolving credit across all three cards is $5,000 + $10,000 + $8,000 = $23,000. The total credit used is $1,000 + $2,500 + $4,000 = $7,500. Therefore, the credit utilization ratio is $7,500 divided by $23,000, or 32.6%.

How Credit Utilization Changes Over Time

A borrower’s credit utilization ratio will vary over time as you make purchases and payments. The total outstanding balance due on a revolving credit account is reported to credit agencies at various times throughout the month.

The timeframe used by lenders for reporting credit balances to an agency can affect a borrower’s credit utilization levels. Be patient; it can take two to three statement cycles for your credit utilization to decrease after paying down debt.

Strategies for Managing Your Credit Utilization Effectively

Shifting credit card balances from an existing card to another will not change the credit utilization ratio, as it looks at the total amount of debt outstanding divided by your total credit card limits. Transferring balances to low-interest cards can help reduce balances over time.

Closing unused credit accounts can lower your credit score by reducing total available credit. Thus, if you continue to charge the same amount or carry the same balance on your remaining accounts, your credit utilization ratio will increase, and your score may decrease.

Adding a new credit card can lower your credit utilization ratio. However, while new cards can benefit credit utilization, they may adversely affect your credit score through increased inquiries.

The Bottom Line

The credit utilization ratio is a key factor in determining your credit score. Maintaining a low credit utilization ratio of below 30% is ideal for a healthy credit score.

Reduce your debt to improve your credit utilization. Receiving more credit lines can also help, too, if you don't use them. But be cautious when opening new credit lines because potential credit inquiries can also affect your score. While acquiring more credit can help lower your ratio, managing existing credit responsibly without closing accounts is essential. Improving credit utilization can positively impact perceptions of creditworthiness from lenders.