Credit utilization is one of the most important, but lesser-known factors of your credit score.
If you don’t know what I’m talking about, listen up: Your credit utilization ratio could be the key to unlocking a great credit score and getting approved for new loans.
What is credit utilization?
Credit utilization – also known as your credit utilization ratio or credit utilization percentage – is the amount of debt you have in comparison to the amount of credit that’s available to you.
How to calculate your ratio
You can calculate your credit utilization ratio by making a list of all of your revolving credit accounts. That means any credit cards or lines of credit you currently have available to you.
Once you have your list together, do the following to calculate your credit utilization:
- Add up the balances you currently owe.
- Then add up the credit limits for all your revolving credit accounts.
- Divide the balance you owe by your credit limit total.
- Multiply that number by 100 and voila! That’s your credit utilization percentage.
Here’s what’s this process looks like with actual numbers:
Let’s say I have two credit cards. I owe $275 on one and $225 on the other, so I owe $500 in total.
If my first credit card has a $2,000 limit and the second has an $8,000 limit, then I have a total of $10,000 in revolving credit available to me.
So my utilization is $500/$10,000. To find out my credit utilization percentage, I divide 500 by 10,000, which is 0.05. Multiply that by 100, and I have my answer: five percent.
The best part is you can check your credit utilization on your own any time you want.
What’s a ‘good’ credit utilization ratio?
Now that you know what a credit utilization ratio is, let’s talk about the best credit utilization ratio to have if you want to achieve a good credit score.
According to Experian, you’ll want a credit utilization ratio below 30 percent. This is so you can score as highly as possible on FICO and VantageScore, the two most popular credit scores.
VantageScore’s blog confirms that 30 percent is the top percentage you’ll want, but mentions that it’s best to stay as close to zero as possible.
In an ideal world, you’ll have an extremely low percentage, meaning you basically pay off your balances each month.
But if you have credit card debt or a line of credit that you can’t pay off in full at once, try to keep the balance below 30 percent of the total amount of revolving credit available to you.
How to establish your best credit utilization ratio
So how do you get a credit utilization ratio of 30 percent or below? Here are three options you can implement.
Option #1: pay down your debt
The most obvious way to decrease your credit utilization is to decrease the amount of credit you’re using. In other words, pay down (or off) your debt.
But like all obvious answers, this is easier said than done.
If you’re having trouble making ends meet, then paying down debt can feel impossible. However, if you start implementing the debt snowball or debt avalanche repayment strategies, you can pick up some serious momentum as you get started on your journey.
With the debt snowball method, you start by paying your smallest debt balance first, while paying the minimum on the rest. Then proceed down the line of debts until you’re debt-free.
But it can take you a bit longer to eliminate debt (and you may incur more interest) when you compare it with the debt avalanche method.
That’s because with the debt avalanche you pay your debt with the highest interest rate first while paying the minimum balances on the rest. However, it may take a lot longer to pay off your high-interest debts first before you can move on to your next debt.
The good news is if you start using either strategy, you’re that much closer to improving your credit utilization by decreasing the amount of debt you’re carrying each month.
Option #2: increase your credit limits
A fast way to get your best credit utilization ratio is to increase your credit limits.
I know this probably sounds counterintuitive. If I just told you to pay down debt, why would I tell you to increase your credit? Well, doing so will automatically decrease your credit utilization percentage.
Think about it this way: increasing a credit limit can have the same effect on your credit utilization ratio as decreasing your balance.
For example, let’s say you have only one revolving line of credit. It’s a credit card with a $500 balance and a $1,000 limit, putting you at a not-so-great 50 percent credit utilization.
Following option #1, you decide to pay your balance down from $500 to $100. Now you have a much better 10 percent.
Or, following option #2, you increase your credit limit from $1,000 to $5,000 without decreasing your balance. Suddenly, you’re at a 10 percent credit utilization ratio.
Note that this rule only works if you increase your credit limit without increasing your balance. If you use any of that shiny new credit limit, then you’re not doing anything to improve your utilization ratio (or your finances).
Option #3: pay down debt and increase your credit limits
If you pay down your debt and increase your credit limits, you’ll really see an improvement in your credit utilization. Not only that, but a lot less of your money will go to frustratingly high-interest rates.
At the end of the day, lenders want to see you using credit responsibly. That means using it and paying it back.
However, a very high utilization signals that you might be struggling to pay your debt back, indicating that you might be a risk. That’s why it’s important to keep your ratio below 30 percent.
By not letting your balances creep too close to your limits, your debt load appears to be manageable, and you seem more like a safe bet to lenders.
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