What is a Credit Utilization Rate?
The credit utilization rate is a calculation comparing an individual's total debt balances to total available credit.
How Does a Credit Utilization Rate Work?
The credit utilization rate is also referred to as the credit utilization ratio. It's used in determining part of an individual's credit score.
The formula for credit utilization rate is:
Credit Utilization Rate = (Total Debt Balance) / (Total Available Credit)
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 Does a Credit Utilization Rate Matter?
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.
Someone with a high credit utilization rate carries a lot of debt or is nearing their maximum credit limit, which looks risky to lenders because they may be less able to repay 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]
