Learning about credit can sometimes create more questions than answers. You need credit to build credit, for example, but how much of that credit do you need to use overall? We’ll need to talk about credit utilization to clear this one up. Read on to learn more about what credit utilization is — and why it’s so important to your credit scores.
What Is Credit Utilization?
Simply put, credit utilization refers to the amount of credit you use compared to how much you have. You can find out what your credit utilization is by following these steps:
- Make a list of all your revolving credit accounts. These are any credit cards or lines of credit in your name or that you’ve cosigned on. This list will not include loans.
- Add up the credit limits on each revolving credit account on your list.
- Add up the balances you owe on each of the accounts on your list.
- Divide your total balance amount by your total credit limit amount and multiply that by 100. The result is your credit utilization, or the percentage of debt you have in revolving accounts compared to your total credit limits.
Now, let’s talk about what this percentage means to your credit scores.
How Credit Utilization Factors Into Your Credit Scores
It’s a common credit myth that you need to maintain a balance on your credit cards from month to month in order to build credit. Using credit is an important component of building good credit — carrying debt is not.
Not only do you not need to carry a balance from month to month to build credit, your credit will do better if you don’t because your credit utilization will be lower. Experts recommend using no more than 30 percent of your total credit limit. And the lower that percentage is, the higher your credit score can be. That’s because credit utilization is a major factor in determining your overall credit score.
Take a look at the chart below to see how credit utilization rates in your FICO® scores (which is part of “amounts owed”):
|FICO® Credit Score Factor||Percentage|
|Length of credit history||15%|
And here’s a look at the level of influence credit utilization has on your VantageScore® credit scores:
|VantageScore® Credit Score Factor||Level of Influence|
|Payment history||Extremely Influential|
|Type of credit and duration of credit||Highly Influential|
|Credit utilization ratio||Highly Influential|
|Total debt||Moderately Influential|
|New credit inquiries||Less Influential|
|How much available credit you have||Less Influential|
As you can see here, credit utilization is a very important factor in building good credit. Focus on that, and you’ll be able to work your way to better credit status.
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How You Can Improve Your Credit Utilization
Lowering your credit utilization may seem difficult, especially if your monthly expenses often outpace your income. After all, if it were so simple to pay down debt, no one would have debt, right?
It might not be easy to pay off debt, but there are things you can do to improve your credit utilization that don’t require a major bonus at work. Below are three steps to consider. Remember, though, that credit utilization is only one factor in your credit score and your overall financial health. You should consider your individual situation (and whether to seek professional advice) before deciding on a course of action.
1. Consolidate Your Debt
Debt consolidation, either through a balance transfer credit card or with a personal loan, can streamline your debt payoff process. If you’re consolidating more than one credit card, you may benefit by bringing them all down to one monthly payment. And, depending on the product you choose, you could end up with a lower interest rate as well.
Besides that, this move can improve your credit utilization ratio. If you consolidate with a new balance transfer credit card, then your total credit limit will go up, making the percentage of your debt smaller. If you consolidate with a loan, your total revolving debt balance will go down, improving your credit utilization ratio.
The only way this step can continue to help you, however, is if you don’t add any new debt. That means refraining from using the card or cards that the consolidation paid off, and not adding new debt to the new card if you choose a balance transfer credit card.
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2. Increase Your Credit Limits
Another thing you can do to improve your credit utilization ratio is ask to have your credit limits increased. You can do this by calling your existing credit card companies and asking them about the process, one that often requires a credit check and can usually be done fairly quickly.
(Keep in mind that the credit check does mean there will be a hard inquiry on your credit report when you request to have your credit limit increased. This won’t have a large impact on your credit score unless you plan to do this with several of your credit cards at once).
If you’re approved, your increased limit will help improve your credit utilization, since your existing debt will make up a smaller portion of your new total credit limit. But, like the step above, it only works if you don’t add any new debt to your card or cards.
3. Focus Your Debt Payoff Efforts on Revolving Credit
Finally, you can improve your credit utilization ratio by redirecting any extra money you have toward paying off your revolving credit. That’s not to say you should stop paying on your loans, but any extra money might be better off applied to your revolving credit first. This has the added bonus of paying down the debt that’s more expensive to maintain since many lines of credit have higher interest rates than fixed loans.