Spending on credit makes shopping super convenient, but be careful about how much you spend relative to your available credit. You may have a high credit limit, but that doesn’t mean you should spend the entire amount every month. Doing so can spike your credit utilization ratio, which can not only increase your debt, but it can also negatively impact your credit score.
So, what’s an acceptable credit utilization ratio in Canada?
Key Points
- Your credit utilization ratio is a measure of the amount of credit you use relative to how much credit is available to you.
- Ideally, your credit utilization ratio should not exceed 30%.
- Your credit utilization ratio is used to calculate your credit score, so keeping it as low as possible is important.
What Is A Credit Utilization Ratio?
Also known as a debt-to-credit ratio, a credit utilization ratio is a measure of the amount of revolving credit you’ve used versus the amount you have available to you. Revolving credit includes accounts such as your credit cards and lines of credit.
What Is Revolving Credit?
Revolving credits are products that do not have any fixed payments. Credit cards and lines of credit are two types of products that fall under this category. With these products, you’ll have access to a certain credit limit, of which you can use as much or as little as you need. The funds you use become accessible again as you repay the balance.
What Is A Good Credit Utilization Ratio In Canada?
Typically, lenders and creditors like to see a credit utilization ratio of 30% or lower. For instance, if you have a credit card limit of $10,000, then you should keep your credit card balances to no more than $3,000 per month ($3,000 ÷ $10,000).
However, keep in mind that “perfect” is subjective and ambiguous when it comes to personal finance and credit scores. Everyone’s personal finance needs are unique, so you should aim to find a credit utilization ratio that suits your financial situation.
Also, your credit utilization ratio becomes more important when you’re applying for new loans or credit, so it’s not entirely necessary to keep your credit utilization ratio at 30% all the time.
How To Calculate Your Credit Utilization Ratio?
Credit utilization ratios are very simple to calculate. The formula is as follows:
Outstanding Debt Balance ÷ Credit Limit
- Find your current balance owed and credit limit – You can find this information on your most recent credit card statements. Alternatively, you can log into your bank account and obtain the most current information. If you can’t find this information, give your bank a call for assistance.
- Plug these figures into the formula above – Divide the current balance owed by the credit limit. You can then multiply by 100 to get a percentage.
Here are a couple of examples of calculating your credit utilization ratio:
Example 1: Single Credit Card Calculation
Let’s say you only have one credit card and no other revolving credit, with a balance of $400 and a credit limit of $1,000. You can calculate the ratio by dividing the balance ($400) by the credit limit ($1,000). The ratio you get is 0.4 or 40 percent if you multiply by 100.
Example 2: Multiple Credit Card Calculation
Let’s say that you have two credit cards, one has a balance of $800 and a limit of $1,000 and the other has a balance of $600 and a limit of $1,500. To calculate your ratio, follow these steps:
- Add the total current balances of both your credit cards. This will give you $1,400 for the current balance.
- Add both your credit limits. This should equal 2,500 based on our example.
- From there, you can calculate the credit utilization ratio by dividing the current balance by the credit limit. This will give you a ratio of 0.56 or a percentage of 56% if you multiply by 100.
Does A Credit Utilization Ratio Affect Credit Scores?
Credit scores are calculated using the information reported to the credit bureaus by your lenders, creditors, collections agencies and other sources. In general, there are five main factors used in this calculation:
- Payment History – Usually accounts for around 35% of credit scores.
- Credit Utilization Ratio – Usually accounts for around 30% of credit scores.
- Credit History – Usually accounts for around 15% of credit scores.
- New Inquiries – Usually accounts for around 10% of credit scores.
- Public Records – Usually accounts for around 10% of credit scores.
As you can see from this list, credit utilization ratios are one of the more important factors when calculating credit scores. However, depending on the credit scoring model used, it may carry more or less weight, which may affect its impact on the credit scores. Broadly speaking, high credit utilization ratios can have a negative impact on your credit scores, while low ratios may have a positive impact.
How To Improve Your Credit Utilization Ratio
Improving your credit utilization ratio means lowering it, you can do so using the tips below.
Increase Your Credit Card Limits
By increasing your credit limit while keeping your spending the same, your credit utilization ratio will shrink.
It should be noted that a credit bureau can penalize you for increasing your limit, as it may indicate an urgent need for funds. Although, this is a short-term consequence, as long as you continue to manage your credit well moving forward.
Keep Your Balances Low
The most obvious thing you can do is keep an eye on your credit card balances and avoid going over a certain limit. It’s also possible to set up balance alerts with your bank so you’re notified when the balance goes over a certain amount.
Be Mindful Of Credit Card Billing Cycles
Since credit card information is updated on your credit report at the end of a billing cycle, try your best to keep the balance low at the end of a period. This way, the balance that shows up on your credit report will be lower, regardless of the activity that went on during the billing cycle.
Pay Your Credit Card Twice A Month
By paying your credit card twice a month, you will be keeping your balance lower regardless of how much activity you have on your card. This method is one of the easiest ways to keep your credit utilization ratio low.
Apply For A New Credit Card
One way to increase the credit available to you is to apply for a new credit card or credit line. As long as you keep your spending in check, this may be an effective way to increase your credit to help keep your credit utilization low.
However, it’s important to understand that applying for new credit can pull your credit score down temporarily due to the hard inquiry involved. Further, applying for too many new credit products in a short period of time will result in frequent credit inquiries, which can further negatively affect your credit score.
Take Out A Balance Transfer Card
If your credit card debt is a bit tough for you to manage, transferring it to a balance transfer card may help. A balance transfer card typically offers a promotional period during which the interest rate charged is extremely low, or even 0%.
By transferring your high-interest credit card balance, you’ll have a certain amount of time to pay down your credit card debt without incurring any interest on the balance. This can both save you money in interest and help you pay your debt down faster. A lower credit card balance can translate into a lower credit utilization ratio.
How Often Is Credit Card Information Updated?
Before making changes to your credit utilization ratio, keep in mind that your credit card information is not updated in real time on your credit report. Usually, credit card information is updated on your credit report when the respective billing cycle ends.
Once the billing cycle ends, your credit issuer will send the ending balance to the credit bureau, at that point, it will be updated on your credit report. This means that you won’t see any changes you make to your credit utilization ratio on your credit report instantaneously.
Debt-To-Credit Ratio Vs. Debt-To-Income Ratio
As mentioned, the terms “credit utilization” and “debt-to-credit” can be used interchangeably. However, it’s important not to confuse debt-to-credit with “debt-to-income”, which are two different things:
Debt-To-Income Ratio
A debt-to-income ratio involves looking at your monthly debts relative to your monthly income. This ratio is typically used by lenders when assessing your loan application and it has no impact on your credit scores. This ratio is calculated by dividing your monthly expenses by your gross monthly income.
For instance, if your gross monthly income is $5,000 and your monthly expenses add up to $2,000, then your debt-to-income ratio would be 40% ($2,000 ÷ $5,000).
Debt-To-Credit Ratio
Again, a debt-to-credit ratio involves looking at your revolving credit usage versus your available credit limit. This is a common factor used when calculating credit scores and typically accounts for around 30% of your credit scores.
Bottom Line
Credit scores are an important part of our financial profile and it can help open doors to different credit products. While your credit utilization ratio is a common factor used to calculate your credit scores, implementing extreme and stringent measures to keep your credit utilization ratio low isn’t necessary at all times. It’s best to find a healthy balance between taking advantage of credit card products and using them responsibly.
