Credit Utilization: What You Need to Know

Credit score health depends on a number of factors—one of which is credit utilization. This number measures your debt to credit ratio and accounts for 30 percent of your credit score. As a major component of credit scoring, you can’t afford to ignore its importance. Read on to learn more about credit utilization and how take advantage of its benefits.

Your ratio: the lower the better. Credit utilization is used by lenders to assess risk. Customers who max out their credit cards are more likely to make poor financial decisions, making it harder to repay existing debts. In general, lenders work with customers whose ratio is 25 percent or less. For example, if Steve has a $6,000 credit card balance and a $16,000 credit limit, he has a credit utilization ratio of 37.5 percent. The average lender will advise Steve to reduce his existing debt before applying for new loans.

The ratio is individual and cumulative. Credit utilization is based on debt and limits, both individual and cumulative. Let’s take another look at Steve’s credit. His $6,000 debt is split between two credit cards:Card #1: $5,500 with a $10,000 limit= 55 percent utilization
Card #2: $500 with a $6,000 limit=8.3 percent utilization

Although Steve’s cumulative ratio is high, his individual card ratios tell another story. Card #1 is dangerously overcharged while Card #2 boasts an acceptable ratio. Steve should repair his credit by reducing the balance on Card #1. This will help him restore his individual and cumulative health.

Credit utilization is negotiable.  The path to better utilization does not always require debt reduction. A simple phone call could help you improve and maintain an acceptable ratio. Consider contacting your provider and asking them to raise your credit limit. This simple act could have a drastic effect on your ratio. In Steve’s case, a $4,000 limit increase on Card #1 would reduce his individual ratio to 39 percent and his cumulative ratio to 30 percent. When the math seems insurmountable, ask your lender for clerical assistance. You’ve got nothing to lose.

Debt management is critical. The best way to control your credit utilization is to practice debt management. Prioritize your credit card usage to keep your ratio below the recommended limit. Consider the strategy of Steve’s financially-savvy niece:

Malia is a 22-year-old who is trying to build positive credit. She has three credit cards with a cumulative limit of $9,000. Throughout the month, she uses the first card to buy groceries, the second to pay for utilities and the third for entertainment and supplies. She pays the balances at the end of the month to prevent accruing interest. This strategy helps her build a positive credit report while managing her utilization ratio.

Put your credit cards to work by assigning expenses to each one. An established list will help you avoid overcharging and allow you to control your utilization ratio.

It may seem daunting at first, but credit utilization is a matter of simple math. Do your homework and allow your credit accounts to work in a positive way. The result will lead to a stronger credit score.

Posted in Credit Score
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