Credit Card Q&A: What exactly is a credit utilization ratio?

Question: I’ve been hearing a lot about credit utilization ratios. What exactly is that? –Todd

Answer: Hi Todd,

Your credit utilization ratio accounts for almost 30 percent of your credit score. This ratio is the amount of credit you’ve used compared to the total amount of credit you have available on your credit cards. An example always helps to illustrate this concept. Let’s say you have two credit cards: A and B. On credit card A, you have a balance of $100 and a credit limit of $1,000. On credit card B, you have a balance of $500 and a credit limit of $1,000.

Your utilization ratio is: 600 (100+500) ÷ 2,000 (1,000+1,000) = .30, or 30 percent. This isn’t a bad ratio, but it’s not great either.  The lower your ratio, the higher your score will be. Likewise, if you have high utilization ratios, your score will be much lower.  This is why it’s a good idea to think twice before closing an account. When you close a credit card account, you’re essentially closing off that available credit limit associated with the card. Let’s say you paid off your balance on credit card A. If you closed the account, your credit utilization ratio becomes 500 ÷ 1,000, or 50 percent. In this scenario, it would obviously be a bad idea to close your account. If you pay off credit card A and keep your account open, you have a utilization ratio of 25 percent (500 ÷ 2,000). So paying off your debt, but keeping the account open, will benefit your score because your utilization ratio goes down.

This isn’t an exact science, of course, because so many other factors are involved. You can learn more about what makes up your FICO score on the education channel at myFICO.com.

[Resource: Get Your Free Credit Report Card]