By now, all of us know how important it is to have a good credit score. However, many of us don’t know how that number is deciphered. There are several earmarks used for the information you see on your credit report.
One of the things that affects your score that you have probably never heard of before is your credit utilization ratio.
Your credit utilization ratio is the proportionality between your total credit limit and your total credit card balance. Knowing a little about the meat and potatoes of this ratio may help you to manage your credit better, which ultimately means a hike in your credit score.
How To Calculate Your Credit Utilization
Go into your credit card accounts and gather the following info:
- Current balance on each card;
- The credit limit on each card.
You’ll be able to find this on your credit statements. Add up the credit limits and the balances separately. Divide the total balance of all cards combined by your entire credit limit and multiply by 100 to get the percentage.
Let’s look at it this way. If you have two credit cards, each with a limit of 2,000, your total credit limit amounts to $4,000. If you have a balance of $1,000 on one card and no balance on the other, your total balance is $1,000 and your credit ratio is 25%. You’re using 25% of the total credit available to you.
The goal when it comes to credit utilization is to get that number as low as possible.
It’s better for your credit scores to have a utilization percentage that’s low
You need to have a look at the utilization rate of each card on its own as well. Work to get the balance down on the card that carries the most. A high utilization rate on individual cards doesn’t bode well for your credit score. Many lenders will look at your total credit utilization ratio as well as ones you have on each separate card.
Also note that the first step in improving your credit score is knowing it. Checking it and having it on hand is the first step in gauging your improvement efforts.
How Does This Affect My Credit Scores?
Certain things come into play when creating your Equifax credit report. Here’s what’s in your credit score: payment history, amounts owed, types of credit you use, new credit you have, the length of your credit history.
Thirty percent of your credit score is relegated to the amounts you owe. One of the most important aspects here is credit utilization. The purpose of a credit score is to see how likely you are to pay your bills late within a two-year time span.
Models used to create credit scores will give a pretty good picture of that likelihood. It has been shown that those who utilize a larger percentage of the limits they have on their credit cards are more apt to fall behind on payments.
Unfortunately, lenders might also assume that you might be living beyond your means and judge you as a higher credit risk. They see good borrowers as not having good credit, but a good credit utilization ratio.
If most of what other information on your credit report is positive, you might still have a relatively decent credit score – that is if you make payments on time or haven’t had accounts go into collections.
When Lower Isn’t Better
Lenders want to see that you’re using your credit, so you might want to use a card from time to time and pay off the balance between the time you get your statement and the due date. That might boost your credit scores.
Should I Maintain Low Credit Utilization For Every Billing Cycle?
Not necessarily. Current balances and limits on credit reports when your score is calculated is what utilization is based on. They come from your most recent credit card statement and not from what’s currently your balance and limit.
There is nothing wrong, though, with striving to maintain a low utilization percentage, especially if you’re aiming for the highest credit score possible (which is 800 or higher, by the way). If your utilization percentage is consistently decreasing, you may be seen as trying to get back on your feet financially and that’s a good thing.
What About Having A Balance On More Than One Card?
When it comes to your credit scores, spreading balances out over several cards, isn’t the greatest idea. If it’s possible, you should look into consolidating your debt onto one account. Your utilization would go up on one card, but it could actually be better that way for your credit score.
In short, here are ways to improve your credit utilization ratio:
- Open a new credit card account;
- Get a personal loan;
- Set alerts for balances;
- Don’t close credit card accounts;
- Accept a credit limit increase;
- Make more than one payment every month.