Your credit score is one of the most important factors in determining your creditworthiness, which can impact your financial health in both the short and long term.
There are many different elements that go into calculating your credit scores, and understanding them is key to making smart choices for your financial future. One of the main factors in your credit report is credit utilization. By keeping your credit utilization low, you can slowly increase your credit score.
There are several ways to lower your credit utilization. Here’s what you need to know about credit utilization and how you can lower it.
What is a credit score?
A credit score is a numerical representation of a person’s current financial standing, and serves as an indicator of the individual’s ability to manage their finances.
Many lenders or companies will request an individual’s credit score to help them determine whether or not to enter a contract with that individual. Future employers, landlords, mortgage lenders, and credit card companies are all examples of entities that may want to see your credit score.
There are a few credit bureaus that use different credit scoring models to calculate your credit score. These bureaus include Experian, TransUnion, and Equifax.
Credit scores consider various factors such as length of credit history, varieties and amounts of total debt, payment history, and more. These numbers are not just generated out of thin air, but depend greatly on your financial transactions.
A good credit score tells potential creditors that the borrower is trustworthy and reliable; conversely, a bad credit score conveys the opposite message. Because of this, it’s important to manage your finances responsibly to maintain a healthy credit score.
What is credit utilization?
The credit utilization ratio is an important part of maintaining a healthy credit score.
It is the ratio of how much credit you use versus the total amount of available credit at your disposal. This is calculated by taking the ratio of total credit limits available to you across all of your credit cards and open loans, minus the amount of outstanding debt you have against those lines of credit.
For instance, if you have $20,000 in available credit out of your total $25,000 credit line, i.e. you currently have a $5,000 balance, then your credit utilization is 20 percent (5,000 divided by 25,000).
Your credit utilization can have a positive or negative impact on your credit score depending on how high or low the ratio is. In general, the lower you can keep the amount of credit utilization, the better it will be for your score (below 30 percent is a general rule of thumb recommended by most experts).
How does credit utilization impact your credit score?
Making up 30 percent of your overall credit score, credit utilization is one of the largest factors in your credit report.
When you have high credit utilization, lenders may be nervous about your ability to repay your balance.
Conversely, if you use just a small amount of your total available credit, you can show lenders that you take on only debts that you are capable of paying off.
Tips for keeping your credit utilization low
Now that you understand how your credit utilization impacts your credit score, it’s time to learn how to lower your overall credit utilization.
1. Pay off your credit cards weekly or monthly
One way to keep your credit card utilization low is to make sure you pay off any outstanding debt frequently, such as once or twice every billing cycle. This keeps your total balance low, which means you are using less of your credit.
Not only can this help keep your debt under control, but it’s also excellent budgeting practice, since you can track exactly how much money you are spending by reviewing your statement regularly. Plus, building credit card payments into your regular budget can help you avoid late payments, limit overspending, and cut down on your total interest.
2. Ask for a credit limit increase
Another way you can decrease your credit utilization is by asking your credit card issuers for a credit limit increase. Every credit card has a credit limit, which is the maximum amount that you are allowed to charge to the card before it will be declined. The higher your credit limit, the less impact the same size purchase will have on your utilization rate.
For instance, if you have a $2,000 credit card limit and a friend has a $5,000 limit card, and each of you has a $500 balance, you will have used 25 percent of your line of credit, while your friend will have only used 10 percent.
If you have a history of paying your bills on time, your credit card company may be happy to give you an increase on your limit if you ask.
3. Open more credit lines
One savvy way to help keep your credit utilization ratio in check is by opening up more lines of revolving credit. This can provide you with additional borrowing power and can also help you spread out the amount you are putting on each credit card account. Because your credit utilization is calculated based on your total credit limit, this can help lower utilization.
Plus, many credit cards offer specific perks such as airline miles, cash back, or members-only deals. By broadening your credit horizons, you might open yourself up to new opportunities!
It’s essential that you make regular payments on these accounts and watch your credit utilization. Otherwise, your credit score may stay the same or even drop.
Before opening up new lines of credit, make sure you do your research.
4. Keep old credit lines open
Another effective tip to keep your credit in better shape is to hold onto old credit accounts, even after you pay them off. Many consumers are unaware that closing their older accounts can actually increase their credit utilization by reducing total available credit, not to mention closing older accounts can also shorten their credit history and lower their credit score that way, too.
Next time you’re taking on a new account and phasing out an old one, don’t forget that keeping the older account open can mean more financial benefits down the line.
Pro Tip: Make sure you still meet the accounts’ usage minimum (i.e. using the card every X number of months to keep it active).
5. Cut down credit card use
Reducing your credit card spending is an easy way to keep your credit utilization rate low. Limiting your monthly spending can help you stay mindful of how much you’re spending and avoid going over budget.
Keeping tabs on these expenses not only helps with keeping your credit utilization low, but it also makes managing your finances straightforward. It’s generally a best practice to avoid spending more money than you expect to make, and building healthy financial habits like this can help you both now and in the future.
6. Refinance with a personal loan
Many people take out personal loans to pay off credit card debt. Doing this can help free up available credit and, in some cases, may come with lower interest rates.
While there are plenty of other effective ways to refinance credit card debt, many people use personal loans because having a few different types of credit can actually help your credit score. If you’re interested in refinancing your credit with a personal loan, make sure to consult with a trusted financial advisor and review your loan terms carefully.
Does keeping a credit card balance boost your credit score?
Carrying a constant credit card balance will not bring your credit score up, but can instead decrease it. While many people may think that keeping a high balance is a good financial practice, it can actually lead to more interest, which can increase your balance and cost you in the long-run.
This can cause your good standing with lenders to decrease over time, potentially affecting future loans and other financial services.
Instead of rolling over unpaid balances from month to month, practice smart budgeting and timely payments on all accounts. Low utilization of available borrowing limits and prompt monthly payments are just some ways to support your credit health.
Credit score and credit utilization: the bottom line
Your credit score is composed of many different components, of which credit utilization is one of the most important. Your credit utilization is a ratio of your total debt relative to your total available credit.
A lower credit utilization rate generally contributes to a higher credit score, as low utilization shows you are a responsible spender who doesn’t depend on credit for all of your expenses.
Generally, keeping utilization below 30 percent and above 0 is the accepted rule of thumb for positive effects on your credit score. Keep in mind that it is also important to make on-time payments every single month, so make sure to make your payments monthly.
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Q&A: What is Credit Utilization? | Credit.org
What is a credit score? | Consumer Financial Protection Bureau
Settling Credit Card Debt | Consumer Advice
Credit card utilization and your credit scores | Credit Karma
Vital Card blog posts are intended for informational purposes only and should not be considered financial or any other type of advice.