Understand Your Credit Utilization Ratio

It's important to keep this ratio low, especially if you plan to apply for a loan soon.

Green Leather Wallet Stuffed with Credit Cards. Carrying too much credit.
(Image credit: iStockphoto)

If I pay off my credit card balance in full every month, does that mean I have a 0% credit utilization ratio?

No, although this is a common misunderstanding. Your credit utilization ratio is based on the amount of available credit that you used over the billing cycle. So if the limit on a card is $20,000 and you’ve charged $5,000 when the numbers are reported, then your credit utilization ratio for that card is 25%, even if you pay the $5,000 in full by the due date. Your total credit utilization ratio is calculated by dividing the total amount you have charged by the total of your credit limits. Lenders look at your total credit utilization ratio across all of your cards, as well as the ratio for each card.

Your credit utilization ratio is based on the information the bank provides to the credit reporting agency. “Whatever balance shows up on your credit report is what’s used in the utilization calculation,” says John Ulzheimer, credit expert at CreditSesame.com. That figure is generally the previous month’s balance that appears on your statement, even if you pay the bill in full by the due date.

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You can achieve a 0% utilization ratio if you plan in advance. Ulzheimer recommends paying off the total balance on each of your cards at least two billing cycles before you apply for a mortgage, or paying off the balance in full by the statement closing date (you can find the closing date on your statement or by contacting your credit card company). “The statement closing date is the end of the 30-day period in which activity on the account is tabulated and the new statement balance is calculated,” he says. “By paying off the balance by the statement closing date, the statement will show a zero balance, which means your credit reports will also show a zero balance for that account.”

In addition to reducing your total utilization ratio as much as possible before applying for a mortgage, it’s wise to keep your total ratio and the ratio for each credit line below 30% at all times, says Chris Mettler, president and founder of CompareCards.com. “Remember: It is not the total amount of debt that matters, but the percentage of available credit that you are currently using,” he says.

For more information, see 9 Secrets to Better Credit.

Kimberly Lankford
Contributing Editor, Kiplinger's Personal Finance

As the "Ask Kim" columnist for Kiplinger's Personal Finance, Lankford receives hundreds of personal finance questions from readers every month. She is the author of Rescue Your Financial Life (McGraw-Hill, 2003), The Insurance Maze: How You Can Save Money on Insurance -- and Still Get the Coverage You Need (Kaplan, 2006), Kiplinger's Ask Kim for Money Smart Solutions (Kaplan, 2007) and The Kiplinger/BBB Personal Finance Guide for Military Families. She is frequently featured as a financial expert on television and radio, including NBC's Today Show, CNN, CNBC and National Public Radio.