When it comes to your credit score, unfortunately you really are just a number. In Canada, credit scores range from 300 (just getting started) up to 900 points, which is the best score. So are you an 850, otherwise known as a credit score ninja, or a 350, otherwise known as… well, someone with a bit of work to do?
When it comes to determining your credit score, a big part of it is your credit card utilization ratio. “Credit utilization is a key part of your credit score because it shows lenders your ability to responsibly manage and pay down debt,” says Heather Battison, Vice President of TransUnion Canada. But the opposite is also true, Battison says, adding, “If you’re using the majority of your available credit, this can negatively impact your score because you could appear risky to lenders who may question your ability to pay back your loans.”
Thankfully, credit card scores are made up of more than just credit card utilization, or CCU. So before we delve into the details of CCU, what are the other factors?
Credit Scores: Know Your Numbers
While a credit score doesn’t paint your full financial picture, it can provide a quick snapshot of your overall financial well-being, which can help you understand how potential lenders may view and evaluate you. It also shines a light on any credit blemishes that you can start to repair. (It’s important to note that because credit card information is updated on your credit report based on billing cycles and not real time, your score may not reflect the most recent changes to your credit card balances and limits.)
So how is credit score calculated? Your number is based on each of the following, with percentages showing how each factor is weighted against the other.
- Payment history (35%). Simply put: on-time payments good, late payments (or no payments) bad.
- Credit utilization (30%). The ratio of your credit card balances to credit limits. There is a sweet spot, which we’ll cover in a minute.
- Credit history (15%). The longer you’ve had lines of credit open and in good standing the more it shows you’re trusted by creditors and responsible.
- Mix (10%). Diversity of accounts (e.g., credit cards, a car loan, mortgage, etc.) that are in good standing shows you have superior debt management skills.
- Inquiries (10%). Seeking to obtain credit from multiple creditors in a short period of time sends up a red flag to creditors that you’re likely having financial trouble.
Calculating Your Credit Card Utilization Ratio
Your credit card utilization ratio (CCU) is the amount of credit you have available versus the amount you’re using. Thankfully, it’s a pretty simple calculation even if you’re not a numbers person! Simply divide your credit card balance by your credit limit then multiply by 100. For example, let’s say the balance on one of your credit cards is $300 and the limit is $1,000.
$300 / $1000 x 100 = 30
So, your CCU for that credit card is 30%. Easy, right?
What is the Perfect Credit Card Utilization Ratio?
Before we get to that magic number, it’s important to know that credit scoring agencies generally look at CCU in two parts.
- Individual CCU for each of your credit cards
- Overall CCU for all of your credit cards (total of all balances compared to the total of all limits)
A high CCU in either category can damage your credit score.
So what is the sweet spot? Financial experts say about 30%, which happens to be the number we came up with in our example above.
You might rationally think that a 0% CCU would be ideal—that means you may have tons of credit available, and have used none! However, not using your cards at all poses another problem. When you go to apply for new credit, like a car loan or a mortgage, lenders will not be able to assess your creditworthiness because you have no current accounts or history to review. That’s why it’s best to try to maintain a 30% CCU.
A Few More Thoughts About CCU
Some people are tempted to cancel credit cards once they’ve been paid off, thinking this will improve their credit score, but this strategy may backfire. Cancelling cards reduces the amount of credit you have available to you, which can actually increase your credit utilization and, subsequently, lower your credit score. So cut up the card or lock it up, but keep the account open.
Maintaining a CCU can also pose a problem for those trying to wean themselves off credit cards. You might think, “I just became debt-free, I don’t want to use my cards again just to maintain a credit card utilization ratio.” That’s understandable—and respectable. But if you need to build a positive payment history, or rebuild credit in order to afford a car or home loan down the road, consider putting a small monthly purchase on the card, like a monthly subscription, and then set up an automatic payment so the balance is paid off each month (and you never forget to make the payment).
Have more questions about credit card utilization rates or building your credit score? Credit Canada’s expert credit counsellors are always available, for free. Contact us today at 1-800-267-2272 or reach us online, anytime.