When it comes to calculating your credit scoresThe three major credit bureaus – Experian, TransUnion and Equifax – may use many different formulas for different situations, but all scores take into account the same major credit factors like payment history, credit mix and age of your accounts.
One important part of your credit scores that might not get as much attention as others is your credit utilization rate. This is a percentage based on the amount of available credit you are currently using. Your credit ratio can change from week to week, or even day to day, and it can represent up to 30% of your credit score.
Find out how the credit ratio affects your credit scores and how paying your credit card bill more than once a month can help boost your credit score or keep it high.
To learn more, find out how debt consolidation and student loan forgiveness could affect your credit score.
What is a credit utilization rate?
Your credit utilization ratio is the percentage of your available credit that you are using. For a basic example, if you have a credit card with a limit of $1,000 and your current balance is $200, your credit ratio is $200/$1,000, or 20%.
VantageScore will only consider revolving credit or credit card accounts in calculating your credit utilization rate. FICO will consider your credit score as part of its “Amounts Due” category, which is the total amount of debt you have.
It is important to remember that VantageScore and FICO monitor your total credit usage (using the balances and credit limits of all your credit cards) as well as ratios for each of your individual accounts. If your overall ratio is moderately low, but you’ve maxed out on one card, it could lower your credit score.
Perhaps most importantly, the credit bureaus do not calculate your credit utilization rate using your current credit card balances. They calculate it using the account balances that your credit card issuers report to the credit bureaus. Each issuer has its own system, but the numbers reported are often your monthly statement balances.
Even if you pay off your credit card balance every month, if you have a high credit ratio at any point in your billing cycle, it could hurt your credit score.
What is a good credit utilization rate?
“It is generally recommended that your credit card balances be maintained at 30% or less of your assigned credit limit,” said Bruce McClary, senior vice president of National Credit Counseling Foundationtold CNET.
While a credit ratio of 30% or less is the general guideline, those who want excellent credit scores will need to keep it even lower. According to the rating company Experian“If your focus is on great credit scores, a single-digit credit utilization ratio is best.”
“The truth is, the lower your balance, the better. The more you carry, the more it could lower your score,” Todd Christensen, head of education at Money adjustmenttold CNET.
But do not aim for a credit ratio of 0%. Experian also says that “the only way to be sure that you have 0% usage all the time is to refrain from using your credit cards at all”, which could lead to your account being closed by a issuer, reducing your available credit and increasing your ratio.
How can I reduce my credit utilization rate?
Since the credit ratio is an expression of the money borrowed divided by the credit limit, the main ways to reduce this ratio are to reduce your debt and increase your credit limit. Here are the best ways to achieve this.
Pay your credit card bill twice a month or more
Credit card companies regularly report your balances to the credit bureaus, and this figure often comes from your credit card statements. Even when you pay your credit card bill each month, if your statement shows a balance that’s a high percentage of your credit limit, your credit score will suffer.
If you use your credit card frequently, consider paying it off twice a month or whenever your balance approaches 30% of your credit limit. Online credit card accounts make it easy to make or schedule as many payments as you want, and you can set up notifications (see below) for your balances.
If you have a $1,000 limit and you spend $900 per month on your card, a credit utilization rate of 90% could affect your credit score. If you pay it off when your balance hits $300, or three times a month, your credit rating shouldn’t be affected by a high ratio.
Create credit card balance notifications
Most credit cards now allow you to create online alerts for your account, including your balance amount. These can be emails, text messages, or alerts through your credit card’s website.
To protect your credit ratio, set up a notification when your balance reaches 25% of your credit limit. This balance level will give you some padding to make sure you stay below the recommended ratio of 30%.
Ask for a higher credit card limit
Increasing your credit limit will help lower your credit ratio, as the amount you owe is now a smaller percentage of the maximum you can borrow. It’s easy to request a credit card limit increase – just call the phone number on the back of your card and speak to a representative.
Before asking for a higher limit, however, keep a few things in mind. This strategy only works if you don’t increase your balance owing. If a higher limit tempts you to spend more, you might want to reconsider.
Also ask your credit card representative if the company will arrange a firm credit check before approving your request. Although a higher limit improves your ratio, a thorough investigation could lower your credit score by 5 to 10 points for about a year.
Keep your old credit cards and use them a little
If you have older credit cards that you don’t use much or at all, don’t cancel them. You will only reduce your overall credit availability and hurt your credit ratio, as well as your average credit age.
However, if you don’t use a credit card at all, the issuer may cancel it for lack of activity. Instead, use old cards sparingly, like buying every few months, to keep your accounts open and your total available credit high.
Once you know the principles of the credit utilization ratio, you can use these tactics to lower your ratio and boost your credit score.
To learn more about best practices for good credit scores, find out how build credit quickly and how to get a free weekly credit report until the end of the year.
Comments are closed.