What Does the Credit Utilization Ratio Mean?

What Does the Credit Utilization Ratio Mean?

by | Mar 8, 2022

You may have heard the term “credit utilization ratio” or “credit utilization rate” before. Credit utilization ratio refers to the amount of revolving credit you currently use divided by the total available revolving credit.  Generally, you express the credit limit as a percentage. Here is more information on credit utilization ratio and how it plays an essential role in the perception of your credit profile.

How Does Credit Utilization Work?

Credit utilization is essentially the ratio of your outstanding credit balance against your credit limit. Therefore, it measures the total amount of available credit you have. Maintaining a stable credit utilization rate is important because it has a significant impact on your credit scores. Credit bureaus have access to your credit utilization, and it’s an essential factor that goes into determine your overall credit score.

Credit scores are calculated based on the most recent information posted on your credit report. They assess credit utilization in two parts. The first is credit utilization based on each card separately. Secondly, it calculates your overall credit utilization, considering the limits and balance along with all your cards.

A credit score’s purpose is to gauge the likelihood that you can repay the money you borrow. That’s why the credit utilization rate is such an important measure. One of the most significant signs of people likely to default on their credit obligations can be a high credit utilization rate. High balances are difficult to afford and are an indication that you’re overextending yourself.

How Is Credit Utilization Ratio Calculated?

Calculating the credit utilization ratio is a relatively simple process. First, you need to take your outstanding credit balance and divide it by the total credit limit. Multiply the result by 100, and you get the credit utilization ratio. For example, you’re using a credit card with a limit of $1,000 and a total outstanding bill of $400. You take $400 and then divide it by $1,000, multiply the answer by 100, and you get 40%, which is your credit utilization rate.

Ideal Credit Utilization Ratio

There’s no magic number that credit agencies prefer. However, financial experts generally state that you keep the rate around 30%. That means if your credit card has a limit of $1,000, you shouldn’t put more than $300 on that card. When you spend higher, it can negatively impact your credit scores. Generally, credit agencies expect that users with a high credit utilization ratio might have more trouble paying back their large debts. The credit utilization ratio is an essential component of your overall credit score. That’s why it’s vital to keep an eye on the credit utilization ratio.

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