Credit Repair

How Important Is Your Credit Utilization Ratio?

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In an ideal world, you’d pay the full balance on your credit card bills each month. But life happens. A medical bill here, an unexpected home repair there, and all of a sudden, you’re carrying a balance from month to month, maybe just on one card or spread over several.

Does that mean your credit score will tank? Not necessarily. Your FICO Score is based on several factors, such as the length of your credit history, your record of on-time payments and your credit mix. One big factor is something called your credit utilization ratio. Knowing what that is and how to control it can help protect your credit score — particularly at times when you may need to rely on credit.

What exactly is credit utilization?

Your credit utilization ratio is, simply put, the percentage of your available credit you’re currently using. For example, let’s say you have four credit cards, each with a $5,000 line of credit. That would mean your overall limit is $20,000. If each of these cards has a balance of $1,000, your overall debt is $4,000, and your credit utilization ratio on those cards would be 20%.

Your credit cards, and other revolving accounts, aren’t the only factor in the “amounts owed” portion of your FICO Score. FICO also considers, for example, the amount you still owe on your car loan or mortgage. All told, the “amounts owed” part of your FICO Score is typically 30% of your grade.

What’s the importance of credit utilization?

If you’re close to the credit limit on one particular card, you may be in danger of “maxing out” the card, or going above the credit limit. You also may be in danger of not being able to make minimum payments, which could put your card in default. To a potential creditor, that sort of high credit utilization may mean you’re a risky bet to extend a line of credit.

Of course, creditors don’t know the full story of why a charge appears on a credit card. They see a $4,000 charge on a card with a $5,000 credit limit as someone using 80% of their credit. They don’t necessarily know that your transmission blew and you needed to get to work, or that you’re expecting a large bonus to pay off the charge in just a few months.

While carrying a high balance on a credit card may cause your score to drop, it shouldn’t do long-term damage. Once you’ve paid off your bill — or once you’ve paid down your debt so the credit utilization drops — your score will likely improve. In general, the rule of thumb is to keep your credit utilization at 30% or lower — both on individual cards and across the cards you hold.

6 ways to improve your credit utilization ratio

Now that you know what credit utilization is and why it’s such an important part of your FICO Score, you should make it a practice to keep yours as low as possible, even when you must carry a balance from month to month. If you do feel your credit utilization ratio is higher than you would like — either on one card or across cards — there are steps you can take to minimize the ratio and potentially improve your credit score.

1. Pay attention to credit utilization on individual cards

While overall utilization matters, the utilization on individual cards is also important. Pay attention to your credit limit on cards, and consider using the one with the highest limit as your “emergency card” to pay for unexpected expenses (not for tropical vacations!). If you do feel like an expense will topple your card past the 30% utilization rule of thumb — and you’re not confident you’ll be able to pay off the card or pay down the debt below that limit at the next billing cycle — consider asking for the payment to be spread across several cards. Setting up autopay across cards (making sure you pay above the minimum) can ensure that you’ll pay bills on time.

2. Pay above the minimum amount owed each month

Remember, the higher your credit card balance, the more interest you’re paying — which can make it hard to pay down debt. Making a note to pay above the minimum each month, or setting autopay to pay more than the minimum, even if it’s just $25 or $50 more, can bring down your bill more quickly than if you were to simply pay the monthly minimum.

3. Regularly check your credit score

Knowledge is power, and regularly checking your credit score can ensure that you’re on the right track when it comes to your finances. A dip can be a sign of something that needs attention — perhaps your credit utilization is too high in a certain month, or perhaps an application for a new card led to a credit check, which can affect your credit score. It’s also smart to make sure all lines of open credit are ones you’ve opened, and that there are no unauthorized or unexpected charges on any accounts you have. If you have gone below 30% or so in your credit utilization, when should you expect your credit score to increase? Your credit score changes each month based on how you’re using your credit, so if you’re actively paying down debt, you should see a positive change in your credit score.

4. Consider requesting a higher line of credit

Requesting a credit increase on an existing card can be a good way to easily lower your credit utilization — provided you don’t add additional charges to the card. While some credit card issuers may perform a hard credit check — a move that can temporarily ding your credit score — many may not, especially if you’ve been a customer who has paid bills on time. To request a credit increase, call your credit card issuer or follow directions online. If you’re nervous about a hard credit check, ask your issuer about their policy.

5. Consider transferring a balance

If you have a history of paying cards on time and using cards responsibly, it may be a good idea to consider transferring a balance or part of a balance to a credit card with a lower interest rate. Some credit cards offer 0% interest for a period of time. While an application for one of these cards may temporarily affect your credit score, as an issuer will likely run a hard credit check on your credit worthiness, remember that new credit accounts for 10% of your credit score. If you have a solid financial strategy to pay back the debt — if, say, you know a bonus is in your future or you’re carefully watching your budget to pay off the bill — then it may make sense to transfer your balance to a card with low or no interest. Just remember that the balance on this card should remain at 30% or less of the overall credit line.

6. Consider a personal loan

If your credit utilization ratio is high on several cards, it may make sense to apply for a personal loan to pay down the credit cards. Applying for a loan will likely trigger a hard credit check, but the credit line of a loan will be added to the overall credit available to you. Only credit utilization affects your credit score, so you may be able to use a loan to pay down credit card balances, then pay back the loan. But even if you lower your balances on a credit card to zero, remember that your credit history is an important element of your credit score, too. That’s why it may be smart to keep the card open, even with a zero balance, rather than close it entirely.

Keep track of your utilization ratio

Knowing how your credit utilization functions can help you be mindful of how you use credit cards, especially for the times when it may be necessary to carry a balance. Having some smart strategies to keep your credit utilization as low as possible can keep your credit score high, giving you peace of mind and options when it comes to financial strategies. If you have done some damage to your credit score, there are services available to help you repair it.


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