How to calculate your credit utilization ratio

This article has been updated from a previous version.

Having a very good or excellent credit score can increase your chances of getting the best interest rates and approvals for higher tier credit products. However, many people may be jeopardizing their credit rating by not considering one crucial detail—their credit utilization ratio.

Lenders may see you as a greater risk if you use a large portion of your credit limit each month, even if you pay your balance in full and never max out your credit card. Using a fraction of your credit limit can increase your credit score and show lenders you are a responsible borrower.

What is the credit utilization ratio?

Your credit utilization ratio, also known as the debt-to-credit ratio, is the amount of credit you use (debt) against your total overall limit (credit).

The difference between payment history and credit utilization ratio lies in what they measure and how they impact your credit score:

1. Payment history (35% of the score): This is the record of your payments on credit accounts, such as credit cards, loans, and mortgages. It shows whether you've paid your bills on time, missed payments, or defaulted on any accounts. Lenders use this to assess your reliability in repaying borrowed money. A strong payment history with on-time payments positively impacts your credit score.
2. Credit utilization ratio (30% of the score): This measures the amount of credit you're using compared to your total available credit limit. It's calculated by dividing your total credit card balances by your total credit limits. A lower ratio is generally better, as it indicates that you're not overly reliant on credit. Keeping your credit utilization below 30% is often recommended to maintain a healthy credit score.

There is a simple calculation you can follow to see if your credit usage falls within this safe zone.

How do you calculate your credit utilization ratio?

Before you can calculate your credit utilization ratio, you will need to determine your overall credit limit and your credit usage.

Your overall credit limit

First, you will need to total the limits of all your revolving credit products. Revolving or recurring credit includes your credit cards, lines of credit, and other credit products where you can borrow, repay and borrow again.

This calculation does not include your mortgage, which is considered an installment loan.

Your credit usage

Next, you’ll need to add up how much you spend and the balances you carry (if any) across your revolving credit products each month.

Read more: How are credit card rates decided?

Calculate your credit utilization ratio

Divide your credit usage by your overall credit limit and multiply that number by 100 to find your ratio. Here’s the formula:

Credit utilization ratio= (your credit usage ÷ your overall credit limit) x 100

For example, if you have two credit cards, one with a $5,000 limit and another with a $2,000 limit, and a credit line of $5,000, you have $12,000 in total available credit.

Here is a table showing how the credit utilization ratio varies by how much credit you are using.

You can also multiply your overall credit limit by 30% to get your credit utilization safe zone. See below.

Credit utilization ratio safe zone= your overall credit limit x 0.30

In this case, we can multiply $12,000 x 0.30 = $3,600. You would ideally spend less than $3,600 across all your credit products—the two credit cards and the line of credit.

Those who have small credit limits may find it challenging to stay below that 30% mark. Someone who has a $500 credit limit would ideally have less than $150 on their credit card at any given time.

Related: Failing to plan is planning to fail: Do you have an emergency savings fund?

How can you improve your credit utilization ratio?

There are a few ways you can improve your credit utilization ratio and, in turn, increase your credit score.

Pay off your balance

In an ideal world, you would pay your balance off in full at the end of each month and not incur interest. However, this scenario isn’t always possible. But, if you can, paying down your balance will lower your credit usage and hopefully get your credit utilization into that safe zone (below 30%).

Increase your credit limit

If you are using your credit responsibly, you may have the option to increase your credit limit. If you typically spend the same amount each month, then you would lower your credit utilization ratio.

If you feel that you can manage a larger credit limit, this may be a great option.

Open a new credit card

Similarly, if you have a credit card with a lower limit, opening a new credit card can add more wiggle room to that overall credit limit.

For example, if you have a card with a $500 limit and you open a new account with a $2,000 limit, you would have $2,500 in overall credit. Before opening the new account, you would ideally spend less than $150 on the card.

After opening the second credit card, you could spend roughly $750 across both accounts and stay within the 30% credit utilization ratio.

But be mindful of "hard credit checks” or inquiries on your credit which occur when a lender looks at your credit report to make a lending decision. Each hard inquiry can slightly lower your credit score because it suggests you're seeking new credit, which might indicate financial stress that may negatively impact your credit score, especially if you have applied for multiple credit cards back-to-back.

To maintain a healthy credit score, it's best to space out your credit applications and only apply for new credit when necessary.

After opening the second credit card, you could spend roughly $750 across both accounts and stay within the 30% credit utilization ratio.

Think twice about closing accounts

Lastly, you’ll want to think twice about closing revolving credit accounts. This decision will not only affect the credit history portion of your credit score, but it will also lower your overall credit limit.

If you spend roughly 30% of your credit limit each month and close an account, it will increase your ratio and mean you are spending more than the recommended amount.

Read next: Is credit card balance protection insurance worthwhile?

Revisit your calculations

The key to building a healthy credit score is to shape your debt management and borrowing behaviours. Be mindful of your credit utilization ratio when you are making larger purchases and when considering closing accounts.

As you change your spending habits or encounter lifestyle changes, recalculate your overall credit limit and usage to stay on track. Consciously thinking about your credit utilization ratio can help improve and maintain your credit score.

Read next: How much does your credit score impact your mortgage rate?