The world of credit is filled with myriad terms and acronyms you probably won’t hear in normal conversation. One of those terms you’re likely to come across when reading about credit scores is ‘credit card usage percentage’ or, more formally, ‘continuing usage ratio’. For the purposes of this article, let’s agree to refer to it as your usage ratio.
Although the utilization ratio may sound confusing at first glance, it is actually not at all difficult to understand and even calculate. And you really have to understand how the usage works. It is the most important of all debt-related measures in your FICO and VantageScore credit scores.
Your credit card usage ratio represents the relationship between your credit card balances and your credit card credit limits as they appear on your credit reports. Another way to describe credit card usage is the percentage of your credit card limits in use in the form of a balance.
Usage is a big deal when it comes to your credit scores. Usage is the cornerstone measure of the debt category, also referred to as indebted amounts, and is worth 30% of the points in your FICO credit scores. The same statistic is extremely influential to your VantageScore credit score.
Regardless of the terms used to describe the metric, they are all used to describe the same thing: the important relationship between credit card limits and credit card balances. One rule applies universally to all credit scores, which is that the higher your utilization rate, the fewer points you will earn and the lower your credit scores will be. So lower will always be better.
The basic formula used to calculate credit card usage, the credit card balance is divided by the credit card limit (balance ÷ limit). Since you are dealing with percentages, you also need to multiply the quotient (the number you reach in this calculation) by 100 (balance ÷ limit x 100 = usage ratio).
Here’s an example of how it works. If your credit card balance is $ 250 and your account limit is $ 1,000, your credit card usage is 25%. In other words, you use 25% of the maximum credit limit for your account.
$ 250 (balance) ÷ $ 1,000 (limit) = 0.25 x 100 = 25% (usage ratio)
The example above shows how to calculate the utilization ratio on an individual credit card account. However, scoring models are designed to look at your individual credit card usage as well as your total occupancy rate.
Total usage is a measure of your total credit card balance against your total credit card limits and is calculated in exactly the same way as individual credit card usage. The only difference is that you must add up all of your credit card balances and all of your credit card limits before following the formula.
Here’s an example:
If you have four credit cards with a balance of $ 1,000 each, your total balance will be $ 4,000. Combine the total credit limits for all of your credit cards to get your total credit limit amount.
For example, if all of your credit cards have a total credit limit of $ 25,000, divide $ 4,000 (your combined balance) by $ 25,000 (your combined credit limit) to get a total credit card utilization ratio of 16%.
The lower that percentage, the better for your credit scores. You can easily calculate this ratio yourself pulling your credit reports and doing the math based on the information it contains.
Almost every article written about usage ratios has common misconceptions, but we’re not going to make the same mistakes here.
One such myth is that all revolving credit lines are taken into account in the FICO and VantageScore revolving usage ratios. This is not true. The continuous use metric is designed to consider credit and credit cards only.
Home equity lines of credit or “HELOCs” are spinning lines, just as credit cards are spinning lines. But HELOCs are not included in the calculation of your continuing usage ratios because they are totally different from credit cards and are not equally predictive of credit risk.
HELOCs are secured by the value of your home. Credit cards are not. If you default on a HELOC, the lender can take ownership of your home. If you default with a credit card, the lender cannot take anything back. Interest paid on HELOCs is tax deductible. Interest paid on credit card accounts is not. The acceptance process of a HELOC is very different from the acceptance process of a credit card. The thing is, the two really don’t have much in common.
Another such myth is that just because you pay your credit cards in full every month, you will have a zero utilization ratio, which is also not true. What matters is the balances that show up on your credit reports, not the fact that you pay them in full every month.
Your credit card activity is not reported to the credit bureaus in real time. Instead, your account information, such as your balance and payment status, is only updated once a month by your creditors on your credit report. That means if you get a credit card statement with a balance, that balance will be reported to the credit bureaus and used to calculate your usage ratios.
To maintain a zero utilization ratio on your credit report, you must pay your entire credit card balance before your statement is generated. This means that you have to pay off the balance before the closing date of the statement, which is usually at least 21 days before your due date.
And finally, what’s the target usage ratio you should shoot at to maximize your credit scores? FICO conducted an investigation that a few years ago quantified the average credit card utilization rate for the top-scoring consumers, those with a score of 750 or higher.
The average credit card usage for this group was 7%. VantageScore suggests keeping your ratio at or below 30%.
Since both FICO and VantageScore credit scores are commonly used by US lenders, it makes sense to be on the safe side and go as low as possible. For example, if your occupancy rate is 5%, you will do very well on both credit score platforms. However, if your occupancy rate is 27%, you might be doing very well on the VantageScore platform, but you’re definitely going to drop some points on the FICO platform.