The second most important contributor to your FICO score is the amount you owe to your creditors as a percentage of the total credit extended to you. (Ugh algebra). This metric is commonly referred to as your “credit utilization” and is calculated as:
Total Balance Across All Credit Cards / Total Credit Limit
Let’s look at a simple example. Let’s say I have 2 credit cards, each with a $5,000 credit limit. I currently have a balance of $1,500 on the first card and $500 on the second card. I would calculate my credit utilization as follows:
($1,500 + $500) / ($5,000 + $5,000)
($2,000) / ($10,000)
In this scenario, my utilization ratio is 20%. I calculated this by summing my total credit card balances ($2,000 across 2 cards) and dividing this amount by my total credit limit ($10,000 across 2 cards). The typical guidance is to keep your utilization ratio below 25-30% (but still greater than 0%) to show the credit card issuers that you can responsibly use and manage your credit lines without overextending yourself.
You can manage your utilization ratio in two ways – increasing the denominator or decreasing the numerator. Let’s first look at increasing the denominator, or your total credit limit. You can do this by increasing your credit limit on your existing cards or by opening a new card. Second, you can decrease the numerator, or your current balance. If you stay below your credit limit and responsibly pay off your new balances every month, this shouldn’t be a worry.