If you have been working hard on repairing your credit, you have most likely heard the term credit utilization floating around a few times.
Since your credit utilization ratio plays a crucial role in your credit score, it is essential to understand what it is and how it works.
Simply put, your credit utilization ratio is the percentage of available credit you have used up. Since your ratio accounts for 30% of your FICO score, it’s important not to overlook this key element.
With that said, you can often expect to see a low credit score accompanying a high credit utilization.
Why do creditors care so much about credit utilization?
When you file an application for new credit (credit card, personal line of credit, loan), the creditor needs to perform a risk assessment by evaluating how much credit you tend to use.
Suppose you are in the habit of maxing out your credit cards or simply racking up a high balance. In those cases, lenders will consider you a higher risk than someone who uses much less of their available credit.
Luckily, there are multiple ways to get your credit utilization down to improve your credit score.
Let’s walk through the different approaches you can take towards improving your utilization ratio.
Figuring out your utilization rate
Calculating your average credit utilization ratio is an easy task; all you need to do is divide all your credit card balances by the total credit limit of all the cards combined and multiple by a hundred.
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Generally, maintaining a credit utilization below 30% is recommended; the lower, the better. As seen in the above example, the average utilization ratio is 23.5%.
We not only recommend keeping your average credit utilization ratio below 30% but each card’s independent ratio as well. Card 2 is hitting 30% and could benefit from a payment.
If you prefer leaving the calculations to someone else, you can use this simple credit utilization calculator here.
How to improve credit utilization
While certain aspects of credit repair can be time-consuming, correcting your credit utilization ratio can be done relatively quickly.
1. Reduce or stop spending money
While this is not always a viable option for everyone if you are determined to improve your credit utilization, tackling your spending habits would be the first step to take.
By not using up the remaining available credit, you can start focusing on step two of the process, which is paying down your balances.
2. Pay off your credit card balances
The best approach to lowering your credit utilization ratio is to pay off as much of your credit card balances as possible.
Since most creditors generally report your credit activity at the end of each billing cycle, we recommend contacting your lenders to confirm which day they will be sending their reports.
This way, you can be sure to make your payment in time. The more you can pay off the balance, the better your chances of improving your FICO score.
If you need to use your card after making your payment, be sure it’s past the reporting date provided to you. The goal is for the lender to report the lowest possible balance.
3. Increase your credit card limit
Requesting a credit limit increase from your credit card company is an easy way to better your credit utilization. This benefit could, however, come with some risk.
This option is not recommended for people who struggle with overspending and budgeting. It would be pointless to request a credit limit increase if the available credit were used up.
If you can ignore the additional available funds, your utilization ratio can quickly descend.
In our original example, if the credit card limit of Card 1 were to increase from $5000 to $8000, that card’s ratio would go from 30% down to 18.75%. What’s more, your average credit utilization would improve by going from 23.5% to now 19.58%.
Note: Unless your credit card company performs an internal review, you can expect a hard inquiry to go through. This would cause a temporary drop in your credit score.
4. Keep your accounts open
Should it come to a time when your entire credit card balance is cleared off, you may decide to close your account. While this may seem like the logical step, it’s best to leave the accounts open (provided you can resist overspending).
Leaving the cards active can have a positive effect on your credit utilization. These open accounts will still be used in calculating your available credit and, as a result, your utilization ratio.
What’s more, closed accounts will eventually be removed from your credit report. Since 15% of your FICO score comes from your credit history, keeping your account opens maintains the length of your credit history.
While many other components play an ongoing role in your credit score, credit utilization remains a large chunk of the equation.
Taking proactive steps towards curbing your spending and paying off your debts is one of the fastest ways of improving your credit score.
Remember your goal, and don’t let your credit utilization creep above the 30% line.
About the author
Clara is the founder of Credit Rise Up, an entrepreneur, personal finance expert, and credit repair enthusiast. She’s committed to helping her readers get on the right track and take actionable steps towards improving their credit by using the experience that allowed her to join The 800 Club. Find out more.