Utilization Rate (Debt-to-Credit Ratio)

Your utilization rate is a factor that makes up 30% of your credit score, so it's important to understand what exactly utilization is and how you can calculate yours.

Understanding utilization rates

Utilization rate (also called a debt-to-credit ratio) is precisely as it sounds: It refers to the amount of your available credit that you are utilizing. Or, in simpler terms, it is the ratio of your credit card balances to your credit card limits.

Ideally, you should have a low utilization rate. To achieve a great credit score, you want to be using as little credit as possible. If your credit card limit is $1000, for instance, you wouldn't want your balance to be higher than 30% of your limit (and some even suggest 10%). That means your credit card balance should never go above $100 on that card. 

How to calculate your utilization rate

The utilization rate on each of your credit cards is just as important as your overall utilization rate. To calculate your overall utilization rate, simply add up all of your credit card balances and all of your credit card limits. Then, divide total balances by total limits. Multiply by 100 to get your overall utilization rate. It shouldn't be more than 30%.

For instance, if I have four credit cards all with various credit limits of $6,000, $8,500, $12,000, and $15,000, I have a total of $41,500 of credit at my disposal. If I were to max out all of my cards, I'd have a nearly 100% utilization rate. This would not be good for my credit score. Instead, I never use the first two credit card, but I routinely have a balance of around $7,000 on the third and $10,000 on the fourth.  This means I'm utilizing about 41% of my total credit ($17,000 divided by my total credit limit of $41,500). Not a great overall debt-to-credit ratio. Also, I'm using 58% of my available credit on card #3, and 67% on card #4. Those numbers aren't so great either. I need to reduce both my overall utilization rate, as well as the rate on both cards #3 and #4.

Don't cancel your cards

Whatever I do, I certainly should not cancel cards #1 and #2. Sure, I don't use them that much, but the credit limits on them are help my overall utilization rate. If I were to cancel those two cards, my utilization rate would jump from 41% to 63%. I'd be better served to keep all four cards open, and let those without any balance on them pick up some of the slack.

Applies to revolving and installment accounts

Utilization rate of your installment loans also affects, to a much lesser extent, your credit score. The closer loan balances are to the original loan amount, the lower your credit score. But before you go and try to pay down large chunks of your car or home loan, know that a good utilization rate on your installment loans may only bring up your score by a few points. So it's probably not worth putting thousands of dollars towards your auto loan or mortgage.

How to achieve a better utilization rate

To achieve a better utilization rate, you can either pay off debt or ask your credit card companies to increase your limits. If you're a good customer, they'll often have no problem doing this. Just be sure that you have the discipline to stay well under those newly raised limits, or you'll end up in a worse spot than you were before: with a bad utilization rate and more debt!