What You Need to Know About Your Credit Utilization Ratio
When it comes to working on your credit score, you likely already know how important it is to make your payments on time, avoid carrying big or overdue balances and be sparing with taking out new lines of credit. However, there is something that can heavily influence your score that is often not well understood. It’s your credit utilization ratio, and it’s one of the five categories determining your credit score.
What is it?
Your credit utilization ratio (or debt-to-credit ratio) measures the amount of debt you owe compared to the total amount of credit available to you. Its’ calculated by dividing your balance by your credit limit for each card you hold. The lower your utilization ratio, the higher your score.
Why it matters
Your credit utilization ratio shows how you use your credit cards each month. Do you max them out month after month? Do you only make minimum payments, keeping your balances high? Or, do you use credit only on what you can afford to pay back? And, do you always pay your bill in full? Your answers to these questions reflect your perceived risk to a lender. Also, your credit utilization ratio is one of the five components of your credit score and according to the FICO scoring model it makes up 30% of your score. It’s the second most important credit score influencer after payment history. So, your credit score will be negatively affected if your credit utilization ratio is high.
How to improve it
Fortunately, your credit score is not frozen in time. As you continue to make improvements to your financial health, it’s likely your credit score will improve as well. This means you’ll want to focus on lowering your card balances and keeping your utilization ratio low. According to experts, a good credit utilization ratio is less than 30%–meaning you use less than 30% of your available credit. Here are some tips to help you get to 30% or below.
Pay more than the minimum payment amount each month. Making your minimum payment each month will satisfy your creditors, but it doesn’t do your credit score any favors.
Keep your balances low. Not only will this help you make more than the minimum payment, but it will also keep your utilization ratio low.
Only use your card for what you can afford. This is generally a best practice when it comes to managing credit. It also makes paying all or most of your monthly balance much easier.
Crunch the numbers. If you’re still unsure of how much used credit is too much when it comes to your utilization ratio, pull out your calculator. Find out the exact dollar amount of 30% of your credit limit. Then, keep a record of every time you use your credit card in a month. Once you’ve hit your magic number (or before that if possible), put your card away until next month. This will remove the temptation and keep your number low.