What is Credit Utilization Ratio?
The amount of money that you currently have as a balance on your credit accounts as compared to the amount of money that you have available to you through those credit accounts is your utilization.
That means if you have $1,000 of available credit and you’ve spent $500 then your credit utilization is 50%. Unfortunately, the higher the utilization the lower your credit score can be. That’s why it’s generally recommended to keep the number under 30%.
If you’re looking to really improve your credit score and make it the best that you can you want to keep that utilization at a good level. That’s because if your utilization is high it looks like you’re spending a whole lot of money on debt and that looks like you’re not going to make your payments.
What this means is if you’re applying for anything new you could end up denied entirely. And if you do manage to get approved you could end up paying some of the highest interest rates because you’re considered higher risk than others.
How to Calculate Your Utilization Ratio?
Now, the good news is that it’s not difficult to figure out your credit utilization rate. You just need to take a look at your credit card statements or online account to find out how much of a credit limit you have and how much of a balance you have.
You can even call the customer service number and get completely up-to-date records of how much you’ve charged versus how much total you have available.
To make it simple, let’s look at three credit cards with different credit limits.
Let’s say that you have a $5,000 limit on your first card but you’ve spent $2,000. On your second card you have a limit of $10,000 and you’ve spent $3,000 and on the third card you have a $6,000 limit and spent $1,000. Your total credit utilization rates would look like this:
Overall you have credit utilization of $6,000 and approximately 28.5%.
Now, keep in mind that this is only an approximation of what the credit report you have is looking at. That’s because they look at the last balance that your credit card companies (or other credit issuing companies) reported to them.
So you may have a higher or lower utilization rate because of those differences in reporting.
9 Strategies To Lower Credit Utilization Ratio
There are good ways to lower your utilization ratio, eash has its own pros & cons – here are the main strategies:
1. Decrease Debt
One way that you can bring down the balance on your cards and your overall utilization is by paying down your debt as quickly as possible. You want to make additional payments each month or pay a little bit extra.
This is going to make it easier to pay off that debt sooner and it’s going to bring down your utilization rate even more during a single payment cycle. You just need to make sure you’re only paying down and not charging more.
2. Get a New Card
It may seem counterintuitive to apply for a new card when you’re trying to lower your debt but it’s actually a good idea. You just want to make sure that you’re not actually using the new credit card.
You’re going to have a little bit of a hit on your credit report because of that new card, but you’re also going to increase your available credit while maintaining your current balances.
This decreases your credit utilization. Just make sure that you’re not going to be tempted to use that new credit card or you could actually find yourself in even more trouble in the long run.
3. Increase Your Limits
If you can get your credit company to increase the limits on the cards that you already have it can also decrease your utilization.
A card that has a limit of $6,000 and you’ve spent $2,000 means a utilization rate of 33%. On the other hand, if you can get a limit increase to $10,000 you change that dramatically.
Now that same $2,000 is only 20% of your total available credit. Just like that you could actually be getting a huge difference and a huge benefit to your overall credit score because you’ve just lowered your credit utilization. Just note that you could also get a hit because of that new credit increase.
4. Know When You’re Being Reported
Your credit card company may report immediately before your payments are due or several days or even a week or more. That means you want to make sure that you’re paying attention to these dates and making a payment quickly before the company reports to the bureaus.
If you make your payments before this time you’re going to get a lower credit utilization score. If you’re waiting to make the payment until the bill is due it could mean that your credit company is reporting a higher amount and that drops your score.
You want to make sure that you’re looking at the reports that you get and statements that you get from your credit company to make sure you know when you need to get a payment in by. You can also call up the customer service line and find out when they’re making those reports. That’s going to give you a chance at an increase on your score as well.
5. Know Your Spending and Set up Balance Alerts
You want to make sure that you’re not spending too much on your credit cards and one way you can make sure of that is to actually make sure your credit card is telling you when you’re spending too much. Keep watching the numbers yourself and stop spending when you get too close to 30%.
You may want to take a look at the online monitoring services available for your credit card and also at the alerts that you can sign up for. Set them to warn you when you get close to 30% utilization on each card.
6. Lower Your Interest Rate
If you can cut down your interest rate it’s going to increase the speed at which you can pay off your cards because you’re going to be paying more toward the principal. You will need to talk to the issuer of your credit card to make this happen and you’ll likely need a good record.
7. Don’t Close Out the Card
If at all possible you want to make sure you keep your cards open. If you have a wider range of different types of credit it looks better for your credit score. And that lower credit utilization rate is definitely going to help matters as well. So make sure you’re keeping accounts open.
If you close an account you’re actually going to increase your credit utilization because you now have less available credit. That’s going to decrease your credit score over time.
Think about it this way:
Let’s say you have a credit card with a limit of $2,000 and you’ve spent $750. The second card has a limit of $3,000 and you’ve spent $500. That’s actually not too bad because your utilization rate is actually 25%. But you’ve decided you don’t need two cards so you get rid of one card and pay off the amount due. Now you have a limit of $2,000 and a total amount owed of $750. It doesn’t seem bad, but your utilization is now 37.5% and that’s not good.
When you’re considering closing out a card make sure you’re thinking about this and that you’re not closing a card that you need to keep your ratios looking good. You could end up with problems on your credit score because you think you’re doing something that will help you out in the long run.
8. Increase Your Payments
Can you make a second payment during the month? Generally making an extra payment is going to increase your score and it could mean that you’re getting that payment in before your credit company is reporting to the credit bureau. That’s definitely going to be an important distinction, don’t you think?
9. Consider a Personal Loan
If you’re really looking at your credit utilization rate you may also want to look at a personal loan. These could pay off your credit card and it could help you improve the types of credit and the credit mix that you’re showing to potential lenders.
You will need to pay attention to the negative sides though, like paying fees to get the money in the first place or getting approved in the first place. Plus, the people who get the best interest rates are going to have the best credit scores. If your credit score isn’t that great you could find yourself in some trouble that way.
Basically you want to take a closer look at your credit utilization and see what it’s saying about you. It’s a great aspect of your overall credit score because it’s actually something you have a lot of control over, and that’s going to help you improve your score.
For those who can’t pay off all of their debt at once, it’s okay. You can make a really big difference by paying off some of the debt and at least lowering the overall debt to credit ratio. That’s going to help you increase your credit score and if there is a reason that you need to get a credit of any kind it’s going to help you out with the process. You may have better luck getting approved.