Contributing Writer at Tally
April 27, 2021
When it comes to your credit, there are a ton of numbers to keep track of: credit score, credit limit, account balances, interest rates and more. One number that sometimes gets lost in the mix is your credit utilization.
Though it's often overlooked, credit utilization can play a big role in determining your credit score and if you get approved for a loan.
To help you better understand this critical part of personal finance, we’ll cover what credit utilization is, how it impacts your credit score and how lenders use it to approve or deny your application.
Credit utilization ratio is the balance on a revolving debt, which includes credit card balances and credit line balances relative to its credit limit. Some people also refer to this as credit utilization rate, credit utilization percentage, or simply credit utilization. You can calculate your credit utilization ratio by dividing your credit card balance by your credit limit, then converting the decimal to a percentage.
For example, if you have a credit card with a $1,000 credit limit and charge $500 on it, you have a 50% credit utilization ratio ($500 / $1,000 = 0.50).
There are two types of credit utilization ratio: account level and overall. The example above is account level credit utilization, as it applies to only one account. Overall credit utilization is all your credit card balances and credit card limits combined.
Say you have three credit cards with $1,000 limits and charge $500 on one, $1,000 on the other and $250 on the last one. In this case, you'd have a total credit limit of $3,000 and a total balance of $1,750 ($500 + $1,000 + $250), so you'd have an overall credit utilization ratio of 58.3% ($1,750 / $3,000 = 0.583).
Only revolving credit impacts your credit utilization ratio. Personal loans, auto loans, student loans, and other installment credit — credit accounts with a set payoff date and fixed monthly payment — impact your FICO credit score. But they don't impact your credit utilization ratio.
Credit utilization is one of the most important factors in determining your FICO credit score. It falls under the "Amounts Owed" category in FICO's scoring model, which accounts for 30% of your FICO score, making it the second-most important factor after payment history.
Ideally, the FICO scoring model wants to see a total credit utilization ratio of 30% or less. Anything more than 30% is high utilization and may harm your credit score.
It may seem logical to believe a 0% credit utilization ratio is the best, but that’s not always the case. MyFICO stresses that using some of your available credit and carrying a low credit utilization ratio may help you reach a good credit score more effectively than using none at all.
That may leave those who pay their entire credit card balance in full every month wondering if they're hurting their scores by having a $0 balance. Don't worry. Though you pay your credit card in full each month to avoid interest charges, what appears on your credit report depends on when the credit card issuer submits your balance to the credit bureaus. Many credit card issuers submit your balance at the end of the billing cycle, which is generally a few weeks before your due date.
Because credit utilization has such a critical role in your credit rating, it plays a significant part in lender approval. However, there are other ways lenders use your credit utilization as well.
Lenders can use your credit utilization history to establish trends. For example, if you frequently maxed out your credit cards in the past, some lenders may see this as a risk and request an explanation. If the lender isn't satisfied with your explanation, they could deny your application.
Lenders also often have to adhere to set debt-to-income (DTI) ratios. Your DTI ratio is your monthly debt obligations — credit card payments, loan payments, alimony payments, child support payments, etc. — relative to your gross monthly income. For example, a mortgage company may not approve you if your monthly debt obligations take up more than 43% of your gross income.
Your credit utilization directly impacts your DTI ratio, as the higher your utilization, the higher your payment will be each month. Keeping that utilization low will keep your DTI low, which increases your chances of approval.
Again, lenders can look at utilization history to determine if you've exceeded the maximum DTI recently and request an explanation.
Lowering your credit utilization ratio is generally one of the quickest ways to improve your FICO credit score. There are several ways to lower this ratio, and some can have near-immediate impacts on your credit score.
Of course, reducing your credit utilization ratio can lower your credit card utilization. You can do this by starting a structured credit card repayment plan, like the debt avalanche or debt snowball.
You can also use Tally's line of credit1, which offers you a credit line that's usually lower than a credit card. You can use this line of credit to pay off your high-interest credit cards and take advantage of the program's other features, like automated payments, paying all your credit cards for you, customizable payoff plans and more.
As your credit utilization ratio nears and reaches the 30% mark, you could see an increase in credit score.
Remember, installment credit has no impact on your credit utilization ratio, and debt consolidation loans generally fall within this category.
If you take out a debt consolidation loan and use it to pay off credit card debt, you may see a quick credit score boost. However, you may also experience small credit score drops, as adding a new account to your credit report can have a temporary negative impact.
Adding a new credit card account to your credit history will increase your total available credit, which will lower your credit utilization. For example, if you have a $500 balance on your only credit card, which has a $1,000 limit, you'd have a 50% credit utilization ratio. However, if you open a second $1,000 credit card, your credit utilization will drop to 25% ($500 / $2,000 = 0.25).
Again, keep in mind that adding a new account to your credit report can drag your score down slightly, so you may not see a large net credit score increase using this strategy.
Another quick way to lower your credit utilization rate is to increase your available credit. You can do so by contacting your credit card issuer and requesting a credit limit increase. Some credit card companies even allow you to make this request online.
Like adding a new credit card, requesting a higher credit limit will reduce your utilization ratio, but it won't have the potential negative impacts of opening an all-new account.
Once you get your credit utilization ratio in check, it's all about maintenance. With a few quick tips, you can keep this ratio under the recommended 30%.
Creating a monthly budget can help you visualize your spending and see where you may be overspending. With this budget, you can ensure you limit credit card usage and keep that utilization ratio under 30%.
Many credit cards offer balance alerts that let you know when you're approaching a certain balance. These alerts can come via text, app notifications or even email. Simply set your credit cards' balance alerts to the credit utilization ratio you'd like to stay under and then try to avoid using the cards once you reach that point.
Your credit utilization ratio is an important part of your personal finances. With a good credit utilization ratio, which is typically under 30%, you improve your credit score and protect your finances by keeping your credit card debt low.
Beyond making up a large portion of your FICO credit score, your credit utilization ratio also plays other roles in lenders approving you for loans. They can also use your credit utilization ratio to determine DTI ratios and flag any recent financial struggles.
If your credit utilization ratio gets over 30%, there's a handful of ways to bring it back below the 30% mark, including:
Paying down debt
Taking out a debt consolidation loan
Opening a new credit card
Asking for a credit limit increase on existing credit cards
And with your credit utilization ratio in check, you can maintain it with budgeting and activating balance alerts on your credit cards.
Want to improve your credit utilization? Learn how Tally can help you consolidate your credit debt and pay down your debt faster.
1To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) Will be between 7.9% - 25.9% per year, and will be based on your credit history. The APR will vary with the market based on the Prime Rate.