The Ultimate Guide to the Credit Utilization Ratio in Canada

Have you ever wondered how your credit card use affects your credit score? We can solve this mystery for you! Do you know what a significant role your credit utilization ratio (CUR) plays in determining your creditworthiness? Perhaps you have yet to learn what it even means.

In this ultimate guide, we will take a closer look at CUR and why it matters. More importantly, we’ll show you how you can manage it properly to maintain a healthy credit profile in Canada.

Understanding Credit Utilization Ratio

Understanding credit utilization ratio affects anyone who wants to keep a good credit score and borrow at competitive rates. For instance, if you have multiple, maxed-out credit cards, you send signals that you have an appetite for risk. On the other hand, if you regularly pay off one or two cards, you have lower, “safer” debt tolerance. 

Obviously, lenders consider this critical factor when evaluating your creditworthiness. In fact, your credit utilization ratio accounts for 30 percent of your total credit score. As such, a high credit utilization ratio in Canada negatively impacts your credit score, making it challenging to get loans or credit card approvals.

What is Credit Utilization Ratio?

Simply put, your credit utilization ratio equals the amount of credit you use relative to the amount available to you. You determine it by the percentage of credit you’ve accessed from your total credit limit across all your credit cards. For example, what if your total credit limit across all your credit cards and lines of credit is $10,000? If you have borrowed $5,000, then your ratio sits at 50 percent. 

To get better interest rates, both Transunion and Equifax recommend keeping your credit utilization ratio below 30 percent. A little less strict, the Financial Consumer Agency of Canada recommends maintaining your credit utilization ratio at less than 35 percent. 

This means you should tap into no more than 30 to 35 percent of your available credit at any given time. Keeping this ratio low preserves a good credit score and increases your chances of getting approved for credit in future.

However, the credit limit used to calculate your CUR only includes revolving credit accounts. In short, think of your credit cards and lines of credit. As a result, your mortgage, car loan and personal loans don’t impact this crucial number.

Revolving Credit vs. Installment Credit

Revolving credit allows you to borrow money up to a certain limit then pay it back over time. Credit cards and lines of credit serve as examples of revolving credit. Installment credit, on the other hand, requires you to make fixed payments over a set period of time. Auto loans and mortgages are examples of installment credit.

When it comes to your credit utilization ratio, only revolving credit factors into the calculation. In short, closely track your credit card balances and lines of credit to keep your ratio low.

However, you must keep up with all of your payments across all types of credit. Even though installment credit isn’t included in your credit utilization ratio, missed payments or defaults can still negatively impact your score.

Why is Credit Utilization Ratio Important?

When lenders evaluate your creditworthiness, they look at your debt load and your credit utilization ratio. Ultimately, this ratio indicates how responsibly you handle credit and how likely you will default on your payments. A high ratio may suggest that you overextend yourself and struggle to make your payments. Meanwhile, a low ratio points out that you manage your credit well.

Furthermore, having a high credit utilization ratio in Canada can hurt your credit score. Overall, this can make it harder to get approved for loans or credit cards with favourable terms and interest rates.

Tips for Managing Your Credit Utilization Ratio

Paying Off Balances Regularly

Ultimately, to maintain a healthy credit utilization ratio simply pay off your balances regularly. This way, you can keep your credit card balances in check and avoid accruing excessive interest charges.

When you pay off your cards regularly, you also demonstrate to lenders that you can manage credit well. This can help you build a strong credit history and raise your credit score over time.

Increasing Your Credit Limit

Here’s another secret to keeping a healthy credit utilization ratio: increase your credit limit. By raising it, you lower your ratio while still paying for items as needed. However, don’t ring up excessive debt just because you set a higher credit limit.

Before requesting an increase, stop to evaluate your current financial situation and ensure you can handle the additional credit well. Additionally, some lenders may perform a hard credit inquiry when you request an increase. Unfortunately, this can lower your credit score for up to two years.

Opening multiple credit cards and lines of credit

When used strategically, having multiple credit cards and lines of credit can effectively reduce your credit utilization rate. The premise works like this: you increase your total credit capacity, while dividing the total between more sources. However, this only works if you also keep your spending constant. 

This may paint a picture of a more responsible borrower in the eyes of lenders. In turn, this can lead to better credit offers and lower interest rates in the future.

However, this approach comes with its own set of caveats. First, you must resist the temptation to spend more just because you have a higher credit limit. Remember, you aim to lower the utilization ratio, not to increase borrowing. 

Furthermore, each time you apply for a new credit card or line of credit, a hard inquiry could temporarily cause your credit score to dip. Instead, manage new credit applications wisely and only open new credit lines to optimize your credit profile.

Monitoring Your Credit Utilization Ratio in Canada

Next, always keep track of your credit utilization ratio. By monitoring your credit card use and CUR, you can gauge how well you manage your credit and adjust as necessary to maintain a healthy credit profile.

You can monitor your ratio by checking your credit-card statements regularly and using free credit score monitoring services. You can also request a free credit report from each of the two major credit bureaus (Equifax and TransUnion) annually. That way, you can review your credit history for errors or fraudulent accounts.

By staying vigilant and proactive about managing your credit utilization ratio, you can qualify for loans and credit when needed.

How to Lower Your Credit Utilization Ratio in Canada

Having a high credit utilization ratio in Canada can hurt your credit score and make it harder for you to borrow money. If you seek to improve your credit score, try these strategies:

Two Strategies for Paying Down Debt

First, focus on paying down your debt as quickly as possible. This means making more than the minimum payment each month and prioritizing high-interest debt first. To do this, you could use the snowball or avalanche methods.

The snowball method creates a momentum of success. It suggests you start by paying off your smallest debt in full, while maintaining the minimum payments on others. Once it disappears, the funds initially directed towards it then apply to the next smallest debt. This step-by-step progression continues until you clear all debts. This strategy provides a psychological boost as you witness debt accounts closing. On the other hand, you end up paying more interest overall since it accumulates on your larger debts.

Conversely, the avalanche method focuses on the financial aspect rather than psychological satisfaction. Here, you concentrate on paying down the debt with the highest interest rate first while keeping up with minimum payments on other debts. Once the highest interest debt is paid off, you tackle the next in line with the second highest rate. 

You can use an avalanche debt repayment calculator to see how this method helps minimize the overall interest you pay over time. Overall, it makes a potentially more cost-efficient strategy, despite demanding more patience.

Balance Transfer and Low Interest Credit Cards

If you’re grappling with high-interest credit card debt, go after a balance transfer credit card or a low-interest credit card. Balance transfer cards shift your existing balances to a card with a substantially lower, often a zero-percent introductory interest rate. This strategy can significantly reduce your interest payments, thereby accelerating your journey to becoming debt-free.

However, be mindful when using balance transfer cards. If you cannot clear your balance before the introductory offer expires, the card’s interest rate will increase. Certainly, you could find yourself back in your initial situation.

Low-interest credit cards, on the other hand, offer a lower interest rate on an ongoing basis. Some of these low-interest cards also provide balance transfer offers, giving you the best of both worlds.

Debt-Consolidation Loans

If you have multiple high-interest debts, you could consider a debt-consolidation loan. This allows you to combine all of your debts into one loan with a lower interest rate. This can make it easier to pay off your debt more quickly.

However, keep in mind that these loans often require good credit; when they don’t, they usually come with a high interest rate. Make sure you understand the terms and fees before taking out a debt-consolidation loan.