Credit Utilization Rate
What it is:
How it works (Example):
The formula for credit utilization rate is:
Let's say you have three credit cards. One has a credit limit of $500, another has a credit limit of $1,000 and the third has a credit limit of $2,000. Let's also assume you carry a debt balance on all three cards. The three card balances combine to $1,000.
Total Debt Balance = $1,000
Total Available Credit = $500 + $1,000 + $2,000 = $3,500
By plugging these two factors into the formula, we can find the credit utilization ratio:
Credit Utilization Rate = ($1,000) / ($3,500) = .2857 = 28.57%
In this case, your credit utilization rate is 28.57%. Looked at another way, this would mean that you are using 28.57% of your available credit limit.
Why it Matters:
Your credit utilization rate tells potential lenders how much debt you are carrying and how much of your available credit you are using. The lower your credit utilization rate, the more favorable it looks to lenders (and the higher your credit score) because it's more likely that you'll be able to make payments on your debt.
About 30% of your credit score is calculated using the credit utilization rate, so if you're serious about raising your credit score, try to keep a low credit utilization rate by paying off excessive debt.
[For more credit building tips, see 7 Steps to Perfect Credit]