Your credit score determines a lot, from whether you can get loans, whether you may obtain personal lines of credit, and what kind of interest rates and repayment terms you can get. Not to mention, it can dictate the insurance options available to you, your interest rates, your cell phone bill, and even your employment and housing options.
Simply stated, a low credit score is hurting you. And if yours is particularly bad, you should immediately work on improving it.
If you want to improve your credit score, your credit utilization ratio is a good place to start. Credit utilization refers to how you manage credit card debt. Specifically, a credit card utilization ratio is the ratio of credit card balances to credit card limits. It calculates the percentage of available credit you use.
Here, we explain how to calculate your credit card utilization ratio, why it is important, and what you can do to improve your ratio.
What is My Utilization Ratio?
Before you can calculate your utilization ratio, you need to know how much you owe and what your credit limit is for each card. Even if you have old cards you no longer use, the credit limits on all open cards should factor into your calculation. You can calculate your overall credit card utilization ratio, or you can calculate your ratio for each card.
To calculate your credit card utilization ratio, divide your credit card balance(s) by your credit limit(s), then multiply that number by one hundred.
Credit card balance/Credit card limit x 100 = Credit Card Utilization Ratio
This calculation yields a percentage known as your credit card utilization ratio. The smaller the number, the better your credit card utilization ratio. Under thirty percent is ideal.
Why is My Ratio Important?
Your credit utilization ratio is a significant factor in your credit score. Behind payment history, it carries the greatest impact at thirty percent of your overall credit score. Credit card utilization ratios are important because this number illustrates your credit usage.
Having a higher ratio tells credit scoring companies that you may be a higher credit risk because you carry a high balance and may struggle to repay debt timely. Statistically, people who use a higher percentage of their credit limits are more likely to struggle with repaying their debts. Therefore, the less available credit you have, the less likely you are to pay your bills on time which is why your credit card utilization rate and payment history carry the most weight in factoring your credit score.
Can I Lower My Ratio, and If So, How?
So, what should you do to improve your credit card utilization ratio? It is important to carefully consider which steps are right for you as some actions, like opening new credit card accounts, can have an immediate negative impact on your credit score even though the long-term impact of increasing your amount of available credit can boost your credit card utilization ratio and therefore, your credit score. If you are committed to the long-term goal of lowering your credit card utilization ratio to boost your credit score, here are a few actions you can take to get started.
Pay more than the Minimum Payment Due
When you are trying to improve your credit utilization ratio, increasing your available credit is a good first step. To have more available credit, you need to reduce any balances you are carrying on your credit cards. And keeping your balances low is the best way to avoid unnecessary credit card debt lawsuits.
The best way to do this is to pay off your credit cards; however, that may not be feasible. If you cannot pay the full balance on your credit cards each month, commit to paying more than the minimum due. The more you pay towards the balance, the more available credit you have. Some of the best credit card consolidation options are geared toward helping you increase your available credit.
Another perk of focusing on paying your credit cards off each month is improved spending habits. Whether you stop using your credit cards for purchases completely, or you reserve your credit cards for emergency expenses only, bad spending habits will disappear. If you do need to use your credit card, spreading out the balance among your credit cards might be an option to consider. In keeping all your credit card balances below thirty percent of the credit limit on each card, your utilization ratio may improve with some credit scoring models.
Avoid Closing Those Old Credit Card Accounts
You may have heard that closing your credit cards can lower your credit score, but have you ever asked why? The more available credit you have, the better your credit card utilization ratio, and the better your credit score. Closing accounts reduces the amount of available credit you have. Even if you have fifteen credit cards, but only ever use one or two, you will benefit from keeping those unused credit card accounts open because they provide you with available credit.
So long as the credit card does not cost you anything, like an annual fee to have the account, keep the credit card open. The credit limit on each open card impacts your available credit, regardless of whether you actually use the card or not. If you do not want to use the card, store the credit card in a safe place at home, or you can even cut it up and securely discard it. As you are working to improve your credit card utilization ratio, avoid closing any accounts that provide you with available credit.
Increase Your Credit Limits
Most credit card providers will periodically increase your credit limit based on your debt management over the life of your account. However, this does not mean you have to wait for the provider to make the change. You can contact your credit card providers and ask to increase your credit limits at any time. Just remember that an increased credit limit should not be treated as permission to spend more. You can continue spending less or avoid using your credit card altogether to get the most benefit from the increased credit limit.
Remember, the more available credit you have, the better your credit utilization rate, and the better your overall credit score. If you are drowning in debt, this can further impact your score, so keep in mind that there are credit card consolidation options out there that can help you chip away at harmful debt.