Introduction
What is credit utilization?
Credit utilization is the percentage of your total credit used from the total available credit. You can calculate your credit utilization ratio by dividing your total credit balance by the sum of all your credit limits. For example, if you have a $10,000 credit limit and a $1,500 balance, your credit utilization would be 15%.
Most lenders prefer clients that use at most 30% of their total available credit, as this is seen as responsible credit management. Realistically, this percentage will make it easier for you to repay.
Why is credit utilization important?
Your credit utilization is one crucial tool used by lenders to evaluate how well you manage your debt and finances. It plays a vital role in determining your creditworthiness in the eyes of lenders.
How does credit utilization impact your credit score?
Credit utilization typically accounts for 30% of your credit score, making it one of the most influential factors. A low credit utilization ratio, generally considered to be below 30%, is positively correlated with a high credit score. Conversely, a high credit utilization ratio, often exceeding 50%, can negatively impact your credit score.
How to Calculate Your Credit Utilization Ratio
Understanding the impact of credit utilization and how to calculate your credit utilization ratio is essential for maintaining a healthy credit profile.
Steps to Calculate Your Credit Utilization Ratio
- Collect your credit card statements or access your online accounts to retrieve the necessary information.
- Add up the outstanding balances on all your credit cards. This represents the total credit you are currently using.
- Sum up the credit limits of all your credit cards. This means the total credit you have at your disposal.
- Divide your total credit card balances by your total available credit.
Here is an example of how to compute your credit utilization:
Suppose you have two credit cards with balances of $2,000 and $3,000, respectively. Your total credit card balance would be $5,000. If your combined credit limits amount to $20,000, your credit utilization ratio would be (5,000 ÷ 20,000) × 100% = 25%.
A credit utilization ratio below 10% is considered ideal and indicates responsible credit management.
What is a Good Credit Utilization Ratio?
Aim to keep your credit utilization ratio below 30%
In Canada, a good credit utilization ratio is generally below 30%. This threshold indicates that you are using your credit responsibly and maintaining a healthy balance between credit usage and credit availability. While even lower ratios are considered better, aiming for a credit utilization ratio below 30% is a practical goal for most Canadians.
Even lower is better, but 30% is a good rule of thumb
Maintaining a credit utilization ratio below 10% demonstrates exceptional financial responsibility and indicates that you only use credit when necessary. This can positively impact your credit score, making you more attractive to lenders and potentially qualifying you for lower interest rates on loans and credit cards.
While achieving a credit utilization ratio below 10% may require consistent effort and discipline, the long-term benefits for your financial well-being are substantial. By managing your credit responsibly and keeping your credit utilization ratio within a healthy range, you can pave the way for a brighter financial future.
How to Improve Your Credit Utilization Ratio
Pay down your credit card balances
A good rule of thumb is to keep your credit card balances low. That is why the best way to keep your credit utilization low is to pay down your credit card balances. This will reduce the amount of credit you use and instantly lower your ratio. Aim to pay off your credit cards in full each month and avoid carrying a balance and accumulating interest.
Avoid opening new credit accounts unnecessarily
Another way to improve your credit utilization ratio is to avoid opening new credit accounts. Opening new credit accounts will lower your credit utilization ratio, as it increases your total available credit. However, it can also negatively impact your credit score in the long run, as it counts as a new hard inquiry on your credit report. Only open new credit accounts if you need to and ensure you can manage the additional debt responsibly.
Ask for a credit limit increase
If you have a good payment history, you may be able to request a credit limit increase from your credit card issuer. This will increase your total available credit, which can lower your credit utilization ratio as long as you keep your current habits and not spend more. However, it’s important to remember that a higher credit limit can also tempt you to spend more, so only request an increase if you are confident that you can continue to manage your credit responsibly.
Conclusion
By keeping your credit utilization ratio low, you can improve your credit score and save money on interest
Maintaining a low credit utilization ratio means you are using your credit responsibly and are not overextended. This is one of the most important factors that lenders consider when determining your creditworthiness. As a result, keeping your credit utilization ratio low will help you:
- Get approved for loans and credit cards with lower interest rates.
- Get better terms on insurance.
- Qualify for better rental properties.
- Save your money on interest.
In addition to these financial benefits, keeping your credit utilization ratio low can also help you to:
- It can reduce your stress. Managing your credit responsibly can help you to feel more in control of your finances and reduce your stress levels.
- It can improve your overall financial health. Maintaining a good credit score can help you to achieve your financial goals, such as buying a home or saving for retirement.
Is your credit score holding you back from achieving your financial goals?
Get your credit score back on track with our help. At Kenny Johnson University, we help you identify and dispute negative items on your credit report, which can improve your score. Contact us today for a consultation.
