It is common knowledge that keeping a high credit score is crucial. This three-digit number affects many parts of our financial lives. For example, it helps us get good loan interest rates. However, the credit utilization rate is an important factor that’s sometimes overlooked.
The credit utilization ratio, sometimes referred to as the credit utilization rate, indicates the portion of your available credit that you are currently utilizing. It is computed by dividing your total outstanding credit card balances by your total credit limits and then multiplying the result by 100. It is commonly reported as a percentage.
Why Does Credit Utilization Rate Matter?
Your credit score is heavily influenced by your credit use rate. It makes up roughly 30% of your FICO score one of the most widely used models for credit rating. Your credit score is used by credit card issuers and lenders to evaluate your creditworthiness and set the terms of any credit agreements they make with you.
How your credit utilization ratio affects your credit scores
Your credit utilization ratio has a significant impact on your credit scores. Here’s how it affects them:
- Direct Impact on Credit Scores: The credit utilization ratio accounts for about 30% of your FICO credit score, making it one of the most influential factors.
- Reflects Credit Management Skills: Lenders and credit scoring models interpret your credit utilization ratio as a reflection of your credit management skills.
- High Utilization Indicates Risk: On the other hand, a high credit utilization ratio indicates that you’re using a significant portion of your available credit, which can be perceived as a higher risk by lenders.
- Credit Score Impact Varies: The exact impact of your credit utilization ratio on your credit score can vary depending on individual factors and overall credit profile. Generally, keeping your utilization ratio below 30% is recommended for maintaining a good credit score.
- Credit Score Changes with Utilization Changes: Your credit score can fluctuate based on changes in your credit utilization ratio. Paying down credit card balances and reducing your utilization ratio can lead to an improvement in your credit score.
- Historical Utilization is Considered: Credit scoring models also consider your historical credit utilization patterns. Consistently maintaining a low utilization ratio over time demonstrates responsible credit management and can contribute to a higher credit score.
Your credit utilization ratio plays a critical role in determining your credit score. Maintaining a low utilization ratio by managing your credit responsibly can help you achieve and maintain a good credit score, making it easier to qualify for loans, obtain favorable interest rates, and access other financial opportunities.
How to Calculate a Credit Utilization Ratio
Calculating your credit utilization ratio involves a straightforward formula:
- Total Credit Card Balances: Add up the balances on all your credit cards. You can find this information on your monthly credit card statements or by checking your account online.
- Total Credit Card Limits: Add up the credit limits on all your credit cards. This information is also available on your credit card statements or online account.
- Calculate the Ratio: Divide your total credit card balances by your total credit card limits, then multiply the result by 100 to get a percentage.
Your credit utilization ratio is 20%, for instance, if you have a single card with a $1,000 credit limit and a $200 load. Your credit usage is 40% if you also have a second card with a $2,000 credit limit and a $1,000 amount; in other words, you owe $1,200 on cards with a $3,000.
It’s essential to remember that this ratio is dynamic and can change each month based on your credit card usage and payments. Keeping this ratio low, ideally below 30%, is generally recommended to maintain a healthy credit score.
How to Maintain a Good Credit Utilization Ratio
Maintaining a good credit utilization ratio is crucial for a healthy credit score. Here are some strategies to help you maintain it:
Regularly Monitor Your Credit Utilization:
Keep track of your credit card balances and credit limits. Regular monitoring allows you to stay aware of your utilization ratio and take action if it starts to increase.
Pay Your Balances in Full and On Time:
Aim to pay off your credit card balances in full every month. By doing so, you can avoid accruing interest charges and keep your balances low, which helps maintain a healthy utilization ratio.
Spread Out Your Spending:
Instead of maxing out one credit card, consider spreading your purchases across multiple cards. This can help keep your individual card utilization ratios lower.
Request Credit Limit Increases:
If you have a good payment history and income stability, consider requesting a credit limit increase from your credit card issuers. A higher credit limit can reduce your overall utilization ratio, as long as you don’t increase your spending.
Pay More Than Once a Month:
If you’re making large purchases that could increase your credit card balances significantly, consider making multiple payments throughout the billing cycle. This can help keep your balances lower when your statement is generated.
Keep Unused Accounts Open:
Closing old credit card accounts reduces your total available credit, which can increase your utilization ratio. Unless there’s a compelling reason to close an account, such as high fees, consider keeping it open to maintain a lower ratio.
Avoid Opening Too Many New Accounts:
Opening several new credit accounts within a short period can lower the average age of your accounts and potentially increase your utilization ratio. Only apply for new credit when necessary and avoid opening multiple accounts at once.
Use Credit Wisely:
Be mindful of how much credit you’re using relative to your available credit limits. Aim to keep your utilization ratio below 30%, although lower ratios are even better for your credit score.
By implementing these strategies, you can effectively manage your credit utilization ratio and maintain a healthy credit profile. Remember that responsible credit management is key to achieving and preserving a good credit score.
Check Out:
- Average Credit Card Debt
- Credit Card Payoff Calculator
- How To Choose a Credit Card
- Paying Off a Credit Card Early
