Credit Utilization Ratio: Understanding and Managing Your Credit Score
Your credit score is one of the most important numbers that will impact your financial life. It affects everything from getting approved for loans, to renting an apartment, to even getting a job in some cases. One factor that plays a crucial role in determining your credit score is your credit utilization ratio.
In this article, we’ll delve into what credit utilization ratio is, how it’s calculated and why it matters so much for your overall financial health.
What Is Credit Utilization Ratio?
Credit utilization ratio (CUR) refers to the amount of revolving credit you’re currently using compared to the total amount of revolving credit available. In other words, it measures how much of your available credit limit you are using on your credit cards or other lines of revolving credit like personal loans or home equity lines of credits (HELOCs).
For example, if you have a $10k limit on a single card and currently owe $2k on that card, then your CUR would be 20%. If you have three cards with limits totaling $30k and owe $9k across all three cards combined, then your CUR would be 30%.
How Is Credit Utilization Ratio Calculated?
Calculating CUR is relatively simple: just divide the total amount of debt owed by the total available limit across all accounts. Here’s an example:
Let’s say you have two different accounts:
– A Visa Card with a balance owing of $1,000
– A MasterCard with a balance owing of $500
The total balance owed between both accounts equals $1,500.
If both accounts have limits where:
– Visa has a limit of $5,000
– MasterCard has a limit of $3,000
The total available limit between both accounts equals $8,000.
To calculate the CUR:
CUR = ($1,500/$8,000)*100 = 18.75%
Why Does Credit Utilization Ratio Matter?
Credit utilization ratio is one of the most significant factors that impact your credit score. In fact, it accounts for almost 30% of your FICO credit score, which is a widely used scoring model in the US.
Lenders and creditors typically view a high CUR as a sign that you may be at risk for defaulting on debt payments because it indicates that you’re heavily reliant on credit to make ends meet. Therefore, having high CUR can negatively impact your credit score and increase the likelihood of being denied new lines of credit or loans.
On the other hand, maintaining low CUR is considered a good indicator of financial responsibility and may lead to better interest rates when applying for new loans or lines of credits.
What Is Considered A Good Credit Utilization Ratio?
The general rule of thumb is to keep your CUR below 30%. However, there’s no one-size-fits-all answer since everyone’s financial situation differs based on income level, expenses, debt obligations and more.
As such, individuals with higher incomes might have more leeway to maintain a higher CUR than those with lower incomes while still maintaining good credit scores.
That said, if you’re looking to improve or maintain an excellent score over time then keeping your overall revolving balance below 10%-20% would be ideal.
How To Improve Your Credit Utilization Ratio
If your current CUR is higher than you’d like it to be – don’t worry! There are several ways you can work towards improving this number:
1) Pay down existing debts: The easiest way to reduce your utilization rate quickly is by paying off some or all outstanding balances across various cards/accounts.
2) Increase available limits: Another option could be requesting limit increases from creditors (if approved), which will automatically lower your utilization ratio without requiring any additional action on their part.
3) Open up new accounts: Opening up new credit accounts can also increase overall available limits and lower your CUR. However, be mindful of the hard inquiries that come with opening new accounts as they might temporarily lower your score.
4) Maintain a low balance: Finally, it’s important to maintain a low revolving balance in general. It’s good practice to pay off balances in full each month if possible or keep them under 30% of the total limit.
Final Thoughts
Having a good understanding of your credit utilization ratio is vital for managing your finances effectively. By keeping an eye on this number and working towards maintaining a healthy ratio, you’ll be well on your way to building strong credit and financial stability over time.
Remember always to make payments on time, avoid overspending or using multiple high-interest credit cards at once, and monitor your credit report regularly for any errors or fraudulent activity that could impact your score negatively.