Credit Utilization Ratio & Why It Is Extremely Important

I always talk about the importance of monitoring your Credit Score via free sites like Credit Karma and Credit Sesame, but in recent days I have realized that there are a few other factors that Readers might not be aware of which ultimately impact your chances of getting approved for a Credit Card.

Yes, I am aware that talking about Credit is not really sexy and in fact quite boring, but ultimately it can be the difference between getting approved for a 100,000 Mile Credit Card and being told, “Sorry, please try again next year”. 

While in the coming weeks, I will do an in-depth posts about Credit Scores, the reason why I am writing about this today is because 2 FFU Readers recently signed up for the SPG AMEX and Chase Sapphire Preferred, and both were denied.

The reason why this is important is because they weren’t denied because of their Credit Scores, Credit History, or not paying their bills on time, instead they were denied because of their Credit Utilization Ratio & Low Credit Limit.

What Is A Credit Utilization Ratio?

Most people know what a Credit Limit is but not that many people are familiar with Credit Utilization Ratios (CUR).

In laymen terms, your Credit Utilization Ratio is how much Credit you are using in comparison to how much Total Credit you have available.

If the Bank gives you Credit Card with a $10,000 Credit Limit, then that $10,000 is your Total Available Credit.

If in 1 month, you put $3,000 on your Credit Card, then you have used up 30% of your $10,000 in Available Credit that month.

Thus your Credit Utilization Ratio is your (Monthly Statement Balance) / (Total Available Credit).

Why Credit Utilization Ratios Are Important

Most of us know the general factors that impact your Credit Score; opening or closing a Credit Card, not paying your bills on time, a short Credit History, etc.  

What most people don’t know is that even if you pay your bills in full every month and never miss a payment, your Credit Score will still go down if your Credit Utilization Ratio is too high.

Of course to normal Consumers, this makes absolutely no sense and is extremely counter-intuitive, but unfortunately those are rules of the game.

For example say you get a Credit Card with a $1,000 Credit Limit, you charge $950 in a month and then pay it off in full at the end of the month.

In most people’s minds, it shows responsibility that you were able to charge $950 and then pay it off in full without incurring interest.

However to a Bank, you look extremely risky because you had to use 95% of your Total Available Credit. They don’t care that you paid it off in full next month.

You have to remember that Banks have millions of Customers who don’t pay their bills on time, so when the Bank sees someone using 95% of their Total Available Credit, their first thought is, “What if this person doesn’t pay their bill this month”.

What makes things even worse is that if you have ever looked at your Credit Report, you will see that next to your Credit Card Account there is a line that say “Balance”. Occasionally, it will say “High Balance”.

Every month Credit Card Issuers like Chase, send a report to Credit Reporting Agencies like Experian and TransUnion about how much your balance was that month.

Occasionally, they will even report the Highest Balance you have ever had on the Card.

So if for 11 months you only spent $100 and then 1 month you spend $950, the $950 is what will show up on your Credit Report!

Again it makes no sense and even my Friends who are Middle Market Credit Analysts at major Banks were dumbfounded when I told them about Credit Utilization Ratios for Personal Credit Cards.

So basically to sum it up, Banks have no problem giving you Credit but they will ultimately punish you if you use too much of your Credit Line regardless if you pay your bills on time.

Real Life Examples

FFU Reader 1 signed up for the Chase Sapphire Preferred in March and was approved with a $5,000 Credit Limit.

Over the last few months, she has used it and always paid it off in full.

Last month she had some big expenses so she charged $3,000 on it.

Unannounced to her, even though she paid off her balance, that $3,000 was reported by Chase to the Credit Reporting Agency which gave her a Credit Utilization Ratio of 60%.

When she went to apply for the SPG AMEX this week, even though her Credit Score is in the mid 700s, she was denied because AMEX is notorious for having really strict Credit standards and her 60% CUR did not cut it.

Another FFU Reader informed me that she just today tried to apply for the Chase Sapphire Preferred Card.

According to Credit Karma her Credit Score is 767, but the only Credit Card she has is a Bank of America Credit Card with a $1,500 Credit Limit.

When she went to apply for the Chase Sapphire Preferred, she was denied.

After calling the Chase Reconsideration Line, they told her the minimum Credit Line on the Sapphire Preferred is $5,000 and because none of her others Credit Cards had a $5,000 Credit Limit, they could not approve her. 

Although FFU Reader 2’s case does not directly pertain to Credit Utilization Ratio, I suspect that it still played a factor since a $1,500 Credit Limit is nothing and you could easily max out your CUR.

Again remember that Banks don’t care that you always pay your bills on time!

The Ideal Credit Utilization Ratio

Since Banks are extremely concerned about Credit Utilization Ratios (CUR), then the next question is what is an ideal CUR? 

Basically Banks want to see that you are using your Credit Card, but not using it so much that you are a risk.

So to meet that requirement, I’d say ideally you want your CUR to be between 5% – 10%, but really the lower the better.

At a minimum, you want to stay below 30% because anything above that can significantly impact your Credit Score. 

Below is my Open Credit Utilization (aka Credit Utilization Ratio) from Credit Karma.

As you can see my Total Available Credit is $40,000, while my outstanding balance is $500, which makes my CUR only 1%!

How To Boost Your Credit Utilization Ratio

While it may sound crazy to only use 5% – 10% of your Total Available Credit (especially if your Credit Limit is really low), there are ways to still use your Credit Card on a normal basis and boost your Credit Utilization Ratio.

1. Increase Your Credit Limit

If your Credit Utilization Ratio is based on your (Monthly Statement Balance) / (Total Available Credit), the easiest way to increase your CUR is to simply increase your Total Available Credit.

If your Credit Limit is $1,000 and your Balance is $900, your CUR is 90%.

However if you call and have your Credit Limit raised to $5,000, then magically your CUR drops from 90% to only 20%!

To get your Credit Line increased, simply call your Credit Card company and ask if they can review your Account and possibly raise your Credit Limit.

It is that easy!

One thing to point out is that when they are reviewing your Account, YOU DO NOT WANT THEM TO DO A HARD PULL.

A Hard Pull is when they actually pull your Credit Report from the Credit Reporting Agency and look over it.

If you apply for a new Credit Card, this is the exact same process that they do and these types of “Hard Pulls” can bring your Credit Score down and stay on your Credit Report for 2 years.

Therefore before they do your Account Review, simply ask what type of pull they are going to do, either Soft or Hard. They will know what you are talking about.

A Soft Pull is where they look at your Credit History in their system and make a judgement based on that information.

So if they see for the last 3 years that you have paid your Credit Card bill on time and never had any issues, then that is enough information for them to raise your Credit Limit.

Ultimately every Bank is different.

I have a Capital One and Discover Card that I don’t really use and the limits are $1,000 and $2,500.

When I called and asked for them to do a Soft Pull and raise my limit, they told me that because I didn’t use the Cards enough, they didn’t have enough data to warrant a Soft Pull, so they could only do a Hard Pull.

I didn’t think it was worth it since I wasn’t planning on using the Cards in the future, so I just left it as is.

Chase on the other hand is pretty accommodating for Soft Pulls and I have never had an issue with having them raise my Credit Limit.

2. Get A New Credit Card

While your Credit Report typically shows the balance on all of your Credit Cards, your Credit Utilization Ratio is based on your TOTAL Available Credit for all your Credit Cards.

So if you only have 1 Card with a $1,000 Credit Limit, then your Total Available Credit is only $1,000.

If you have 2 Cards, 1 with a $1,000 Credit Limit and another with a $10,000 Credit Limit,  then your Total Available Credit is $11,000.

This makes a huge difference because every month when the Credit Reporting Agencies calculate your CUR, the larger your Total Available Credit, the lower your CUR!

Again this may sound counter-intuitive, but if you only have 1 or 2 Credit Cards, I suggest getting another as it will lower your CUR and increase your Credit Score.

The reason for this is because it basically spreads around the risk for Credit Card companies.

If Chase sees you only have 1 other Credit Card from Bank of America that has a $1,000 Credit Limit, they might be reluctant to give you a Card.

However if Chase sees that you have a Bank of America Card, an AMEX Card, and a Citi Card, they will see that 3 other companies have also trusted you with Credit, so they will be more open to giving you a Card.

At its most basic level, “Credit” is how trustworthy you are in paying back your debts (unless you are a Lannister then you always pay your debts)!

Thus the more Credit you have available, the more people have trusted you to pay back your debts, the more credit-worthy you become. 

3. Pay Your Credit Card Bill Before The Statement Date

This tip I provide mostly to College Kids who are just getting their 1st Credit Card since their limit is typically like $250, however it is something that everyone can do to boost their CUR.

My Cousin ran into this exact problem because he has a real job now that pays real money, but he didn’t have a Credit History. Thus Capital One only gave him a $250 Credit Limit on his first ever Credit Card.

He just moved to Seattle and had to buy apartment furnishings but since his Credit Limit was only $250, he didn’t know what to do.

A single $250 purchase could easily push his CUR to 100%, which is never good if you just were issued your first Credit Card and don’t have any prior Credit History!

Ultimately my suggestion to him was to simply buy whatever he needed (as long as it was not over his $250 Credit Limit), and then simply pay off the balance before the Statement came out.

This will not affect his CUR because your Credit Card information is only sent to the Credit Reporting Agencies once a month after your Statement comes out, and again the Banks only send your Outstanding Balance information. 

So if my Cousin’s Statement is processed on the 1st of every month, then from the 2nd of every month until the the start of the next month, he can spend whatever he wants on his Card as long as he pays it off before his next Statement comes out.

For example if his Statement came out on August 1st and on August 2nd he went to and buys a bedding set for $225, if he pays his new $225 balance off once he gets home, then his Total Available Credit once again drops back to $250.

Once his Total Available Credit is back to $250, he can go out the next week and buy some more stuff for another $100, and pay off $90 when he gets home.

When his Credit Card Statement comes out September 1st, assuming he makes no additional purchases, it will show that his balance is $10, so he only used 4% of his Total Available Credit that month, when in reality he charged over $325 that month!

To the Capital One it will look like he is low risk with 4% CUR, all while he is still able to use his Credit Card to buy stuff that he actually needs without being tied down to the $250 a month Credit Limit.

While this is an extreme case since my Cousin’s limit is so low, I highly encourage those of you even with a $10,000 Credit Limit to do this if you ever have a huge purchase that bumps up your CUR.

I just bought a $1,500 Road Bike on my new SPG Business AMEX which has a $6,000 Credit Limit.

I know that AMEX is really stingy about Credit, so instead of waiting until my Statement comes out next month where I will have used $1,500 of my $6,000 in Total Available Credit, a few days after I bought my bike, I simply paid $1,250 towards my balance.

This way when my Statement comes out, it will show an outstanding balance of $250 (4% CUR) instead of $1,500 (25% CUR).

The best part is that you still earn Points and Miles for those purchases even if you pay them off before your next Statement comes out!

Recap

Hopefully for those of you that were not aware of Credit Utilization Ratios, this sheds some light on the topic.

Although CUR is important, don’t let it drive you nuts and force you to start paying with Cash or your Debit Card.

If your CUR goes over 30%, simply pay down your balance before the Statement comes out!

If you monitor your Credit Score via Credit Karma or Credit Sesame, I guarantee if you keep your CUR under control, you will see a gradual rise in your Credit Score. 

I’ll probably be writing more about the exciting world of Credit in the future, but in the mean time feel free to ask me any questions you might have!

-Parag 

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