If you want to take out a loan or get a new credit card, a financial institution will check your credit scores to decide whether to approve your application and to set your interest rate. Your credit utilization ratio is one of several factors that influence your credit scores.
How to Calculate Your Credit Utilization Ratio
Your credit utilization ratio is the percentage of credit available to you that you’re currently using. To calculate the ratio, add up the balances on all your revolving lines of credit (i.e., credit cards, home equity line of credit). Next, add up the credit limits for all those accounts. Divide your total balances by your total available credit, then multiply by 100 to get a percentage.
How Your Credit Utilization Ratio Can Impact Your Financial Future
Lenders generally like borrowers to have credit utilization ratios under 30%. A ratio above that threshold can indicate that you’re taking on more debt than you can afford and struggling to keep up with your payments.
A high credit utilization ratio can drag down your credit scores and make it hard to qualify for a loan or credit card with a competitive interest rate. A particularly high ratio might keep you from getting approved at all.
How to Improve Your Credit Utilization Ratio
Lowering your credit utilization ratio can raise your credit scores and help you get a loan or credit card with favorable terms. There are two ways to reduce your ratio.
One strategy is to pay down your balances. You can cut back on your monthly spending and/or find a way to boost your income so you can put more money toward debt payments. You might also be able to transfer balances, lower your interest rates, pay off your debts faster and save money on interest.
Another approach is to increase your total available credit. Even if your outstanding balances remain the same, when you divide that amount by a larger number, your credit utilization ratio will be lower.
If your income has recently increased or your credit scores have improved, you can contact your credit card issuers and request higher limits or open a new credit card account. If you request a new line of credit, the company will perform a hard inquiry. That can cause a temporary drop in your credit scores.
Many people find that when they have more available credit, they spend more and get themselves deeper into debt. If you’re not disciplined enough to keep your spending under control, don’t increase the amount of credit you have access to. Focus instead on paying down your balances.
