What is a Credit Utilization Ratio & Why is it Important?
Your credit utilization ratio (CUR) is an important number that tells a lot about your financial situation. Unfortunately for many borrowers, it’s not a common or well-known concept. Let’s clear up any confusion so you can be a master of your CUR.
What is a Credit Utilization Ratio?
Your CUR depicts your credit usage in the form of a percentage. More specifically, it shows how much credit you use on a scale of 100, with 100 being the maximum.
This ratio only applies to revolving, open-ended accounts, like lines of credit and credit cards. While you might have multiple personal loans in your name, none of these affect your CUR.
How Do You Know What Your Ratio Is?
Crunching the numbers is easy. For individual accounts, you just need to know your current balance and the account’s formal limit. Once you have these numbers, divide your balance by your limit, then multiply the product by 100 to get your percentage.
For example, if you have an account worth $5,000 and you’ve used $3,000 of it already, your utilization calculation would look like this:
$3,000 / $5,000 = 0.60
0.60 x 100 = 60%
Do You Want Your Ratio to Be 60%?
In the example above, the utilization ratio comes to 60%. In the academic world, that’s underwhelming but not necessarily that bad. Unfortunately, things are flipped in the financial world.
A full 100% indicates you have maxed out your accounts, which is bad for a few reasons.
1. You’re Vulnerable to the Unexpected:
Most people rely on the plastic in their wallets for life’s unpredictable expenses. But if your CUR is at 100%, there’s no room on this account for another expense. You may have to take out an additional line of credit in an emergency. Reach out to an emergency line of credit lender to learn more about how it works and what you need to apply.
2. It May Damage Your Credit Score:
Depending on how your lender reports your payment history and account information, your utilization ratio may contribute to your score. Most credit bureaus view a high ratio critically, as it indicates you max out your revolving accounts and don’t pay them back.
3. You Have to Pay it Back:
Eventually, you’ll have to pay back what you owe. Until you do, you’ll earn more in compounding interest and possible finance charges. How much they cost depends on your lender and your agreement.
So, What is a Good Utilization Ratio?
Now that you know a high CUR is bad, it’s obvious that a low one is better. But just what ratio earns you top marks? The thing is, there is no perfect number that works for everyone.
Some financial advisors say you should keep your CUR below 30%. This is a realistic limit for people who regularly rely on revolving accounts for everyday shopping, and it keeps you from maxing out your accounts.
However, consumers with the highest scores tend to keep their CUR lower than 10% and may be as low as 1%.
Your CUR reveals how much you rely on revolving accounts, and how often you pay off your debts. Keeping yours low can help you manage your spending, keep credit available in emergencies, and possibly improve your score.