Credit utilization is the percentage of your total credit that you are using or the amounts you owe. It is critical to maintain a low utilization ratio since it is the second-most important factor in your credit score.
A low credit utilization ratio can improve your credit scores, but a high utilization ratio can negatively impact them. Learn more about credit utilization, how it works, and how to improve it by reading this blog.
How does the credit utilization ratio work?
Credit utilization is the percentage of your total available revolving credit, such as personal lines of credit and credit cards. The balance on your installment loans, which comprises personal loans, isn’t included in your credit utilization ratio calculations, but it can impact your credit score.
There are two utilization rates: individual account utilization and your overall utilization. Credit scoring models like FICO divide the reported revolving balance by the credit limit on your credit card or line of credit to determine your individual utilization rate.
Your overall credit utilization rate shows the comparison of all applicable revolving balances and the limits. Nonetheless, both can be critical to your credit score.
How does credit utilization affect your credit score?
Your credit utilization rate can profoundly impact your credit score, but the specific effect will depend on the type of credit scoring model and your overall credit profile.
For instance, FICO lists revolving utilization as a subcomponent of the amount ‘owed portion’ of its scoring formula, which can make up for about one-third of your FICO score. In the meantime, VantageScore lists credit usage, balances, and available credit as significantly influential for its scores.
A low credit utilization rate in both individual and overall accounts is typically better for your credit score. Making sure your overall utilization rate remains below 30% can be a helpful guideline, but those with the highest credit scores generally have utilization rates below 10%.
It may seem odd, but a low utilization rate, such as 1%, is better than no utilization rate at all. That’s because credit scores are designed in a way so they can predict how you’ll repay a loan in the future.
By lowering your credit utilization rate, you can quickly improve your credit score since most scoring models consider your utilization rate as it is reported. You can boost your credit score quickly if you pay off a high utilization rate at once.
Six ways to improve your credit utilization
1. Ask your card issuers for a credit limit increase.
A higher credit limit can lower your credit utilization rate, making it easier to maintain a low rate. So simply ask your credit card issuer to increase your limit. However, one of the downsides is that your request may lead to a hard inquiry, causing a temporary dip in your credit score.
Additionally, check the annual income amount you reported to the credit card company that you can find on your online account. You can update the amount if your income has risen, and this may help get you approved for a higher credit card limit or lead to an unrequested increase.
2. Pay down your balances early.
Lower your credit card’s balance before issuers report it to the bureaus since this can lead to a lower utilization rate. The reporting often occurs at the end of each statement period, but you can connect with your card issuer to confirm the same.
Make early payments if you’re carrying a balance. It can help you save money since credit cards often accrue day-to-day interest.
3. Spread out your spending among several accounts.
Spreading out your spending across several accounts won’t decrease your overall utilization rate, but it could keep you from maxing out one of your cards.
The utilization rates of your individual accounts can also be the scoring factors. One way to improve your credit score is by keeping any single account from having a high credit utilization rate.
4. Open a new credit card.
Opening a new revolving credit account, such as a credit card, can boost your total available credit. Be careful as you may feel tempted to spend more using your new card, plus it may carry an annual fee.
Use your new credit card carefully, or you could end up racking debt and increasing your utilization rate instead of decreasing it.
5. Refrain from closing your credit cards.
You may want to keep your credit cards open to maintain more available credit. Closing a credit card makes sense when you don’t want it because of the annual fee or have concerns about overspending. But if there’s no annual fee and you use it rarely, keeping it open can help your credit score.
You could use your card to pay small monthly bills and even turn on the autopay feature to ensure you’re never late with your payments and avoid account closure due to inactivity for a long time.
6. Become an authorized user.
One of the fastest ways of improving your credit score is to become an authorized user on someone else’s card. Generally, credit card issuers report accounts to the credit bureaus under both primary and authorized users’ names, which can help build your credit.
It is good to remember that by becoming an authorized user, you give up some control as well. For example, if the primary cardholder generates a high utilization rate, it will reflect on your credit report too, and your credit score is bound to suffer should they fail to make timely payments.
Managing and tracking your credit card balances, credit limits, and statement period end dates is a prudent task from a personal finance perspective. The most practical way of managing your utilization rate is to make payments before issuers report your balances to the credit bureaus.
Another way of managing a low utilization rate is to limit your expenses by following a budget, steering clear of overspending, or paying in cash. It’s generally better to avoid using credit cards for big purchases since this helps prevent accruing high-interest debts.
If you’re not sure how to work it all out, take the help of Cool Credit. The team of experts at CoolCredit will make sure to check and dispute any negative items on your credit report that you may be unaware of that could be affecting your credit utilization rate.
Schedule a free consultation with Cool Credit today to get started immediately.