Despite the rather intimidating-sounding terminology, credit utilization is not as complex as you might think. Credit utilization is defined as the ratio of your outstanding credit card balance to your limit. In plain English – it’s basically the amount of credit you are NOT utilizing on your credit card. 

The basic formula for calculating credit utilization is to divide your credit card balance by your credit card limit, then multiply by 100. For example, if you have a $10,000 credit limit and a $5,000 balance, your credit utilization is 50%.

However, a credit utilization of 50% is not ideal. In fact, the lower the percentage the better, but we’ll get more into that later. In fact, we’ll guide you through a better understanding of credit utilization, how it affects your credit rating and ways you can improve it when needed.

What is considered good credit utilization – and how does it affect your credit score?

As we mentioned above, a credit card utilization ratio of 50% is not considered healthy. You want that percentage to be no more than 30-35%. According to credit bureaus, the less credit you are using, while still having it available, signals your ability to properly manage your personal finances. Having credit – but not needing it – goes a long way with those who judge our credit scores. This doesn’t mean you should start applying for multiple credit cards and not use them. Instead, you should apply open new credit card accounts sparingly and as needed.

Your credit score is a combination of multiple factors, as we have handily displayed in the pie chart below.

Pie chart with breakdown of credit score factors. Credit utilization makes up 30% of your credit score.

As you can see, credit utilization takes up the second-largest slice of the credit score pie after your repayment history (35%). Rounding out the remaining 35% is a combination of your credit history, credit inquiries, and public records.

According to TransUnion, one of the top credit bureaus in Canada, using the majority of your available credit can negatively impact your score because it shows you as a potential risk to lenders. In other words, you are perceived as potentially not being able to pay back a debt if you are maxing out credit cards. Higher balances are more difficult to maintain and could indicate you’re prone to overextending yourself. As we said, try to keep your credit utilization under 30-35% and this shouldn’t be an issue.

Can credit utilization be too low?

It may seem counterintuitive to what we are saying about keeping a low credit utilization ratio, but it is possible to have too low a ratio. If you’ve been carrying a $0 balance for several months, for example, you have no information being sent to the credit bureaus, which update your profile every month based on payment cycles. So, if there’s no activity, you are not adding to your payment history and not giving potential lenders and creditors any information about your borrowing history. Remember: keep your credit utilization rate low, but not so low that you cease to exist.

How can I get a better credit utilization ratio? 

Now that you have a better understanding of credit utilization and how it affects your credit rating, it’s time to discuss ways to manage your credit utilization and ways to rehab it if necessary. A straightforward technique used by many is to set up balance alerts on your credit cards. Calculate what the 30% ratio is on your credit limit – say a $3,000 balance on a $10,000 limit – and set alerts to notify you of when you’ve reached that threshold. 

1. Pay down debt

Here’s our “no duh” solution to improving your credit utilization – pay down your credit card debt as best you can. Try to pay your credit cards twice a month, if possible, and start freeing up available credit. If you hold multiple cards, spread out your repayments across all the cards so that your utilization ratio is better on all the cards versus just one. Many credit scoring models calculate the utilization on all your credit cards to determine their overall credit score for you. 

Also, try to hold off any new purchases on those cards until after the end of your billing cycle. This will ensure your credit card issuer reports your low balance information to credit bureaus and you get a positive report.

2. Raise your credit limits

Be careful here. One way to lower credit utilization is to increase your credit limits. By increasing available credit, you can lower that utilization percentage. This is a risky technique, no question, because metaphorically speaking you are asking for more rope to hang yourself with. Still, it can work if you’ve got the self-discipline.

Here’s an example: you have a $10,000 limit and a $4,000 balance, equaling a 40% credit utilization. Not optimal. However, if you were successful in getting your limit extended to $15,000, your ratio would drop to 26%, making a substantial improvement to your credit score. Easy right?

One issue with this method is that extending credit is not always a stroll in the park. Your card issuer is going to evaluate whether you qualify for more credit, which could require you to earn more income and have a clean credit history. An unfortunate twist to all this is that requesting a credit limit increase, known as a hard inquiry, can lead to a temporary downgrade on your credit score by credit bureaus.

3. Don’t throw away your cards

 You may be thinking an obvious solution to manage solid credit utilization is just never use your cards, toss them in the freezer or get out the rusty scissors and slice. Not so fast. As we mentioned earlier, no activity on your credit card is not necessarily better than some small activity. You need to be actively making repayments to keep your utilization and overall credit score healthy.

Find a happy medium between no-use and just-enough-use to keep you in the credit repayment game. So, we recommend you don’t go crazy with those credit cards, but we also recommend you don’t cancel them either.

Fixing your credit utilization – timing matters

Credit card issuers send your information to credit bureaus every month – you want to be sure they deliver info that most benefits your credit score. It’s usually a few days after your billing cycle when they send their report, meaning you should get your balance down before that happens. 

Careful with this because your payment due date is not always aligned with when they send their report. If you’re unsure when they file their info to the bureaus, simple call your issuer’s customer service line and ask for that timeline. Doing this can help lift your credit utilization score and keep you on top of your credit card bill payments. 

Is it a good idea to get a personal loan to pay off credit cards?

If you’re ready to get serious about raising your credit score and want to pay off high-interest credit cards, a personal loan might worth considering. With a personal loan, you can simultaneously lower your credit utilization AND diversify your credit mix when you move at least some of your revolving credit to installment credit.

With regards to paying down credit card debt, a personal instalment loan can be advantageous in two ways:

  1. A personal loan is ideal for debt consolidation and might suit your circumstances if you have multiple credit cards with multiple payment dates. A debt consolidation loan can help you merge all payment dates into one. With only one payment to remember every month, it could make your debt easier to manage. A balance transfer credit card essentially does the same thing and might also be worth looking into.
  2. Credit cards are a form of revolving credit where you can decide how much you want to pay each month. If you choose to only make the minimum payment, your debt can seem never-ending. Personal loans, on the other hand, offer a fixed loan term with monthly payments over a time period of your choosing, usually up to 60 months. Gradually paying off your loan instalment by instalment can be easier to budget and plan for.

Take note, if you don’t have good credit, it might be hard to get approved for a personal installment loan at a lower interest rate. You might want to look at ways to improve your credit score before applying for your loan.

When you’re ready to apply for a personal loan, make sure to shop around and compare lenders. Some lenders have lower interest rates than other lenders. Some lenders charge fees. However, there are lenders—like Fresh Start Finance—that do not charge application fees or maintenance fees, so make sure you find a lender that doesn’t come with any surprising hidden costs.

Fresh Start Finance serves Canadians facing all types of credit situations with practical advice and credit-building solutions. We also offer quick-and-easy secured and unsecured installment loans to help you take those first steps to a better financial future. Apply today to see how we can help!