Why Credit Utilization Is Important To Your Credit Score

To understand why credit utilization is important to your credit score, you must first understand what credit utilization is. Once you know what it is you need to explore how it affects your credit score in both negative and positive ways.

What is Credit Utilization?

Your credit utilization is also known as your debt-to-credit ratio. It is essentially a review of how well, or how poorly, you use your credit cards. It is the amount of credit you have available on your credit cards compared to how much you actually owe. To calculate your credit utilization you simply add up all of your credit card debt (the amount you owe on all of your credit cards) and divide by the total of your credit card limits. The fraction you arrive is your debt-to-credit ratio. For example if your credit card limits add up to $1,000 and your total credit card debt owed on those cards is $700 your ratio is 7/10. If you now multiply the fraction by 100 you will arrive at your credit utilization ratio or rate which is 70% and is considered quite high. It is important to understand why that is considered high and how it affects your credit score.

Why Your Credit Utilization is Important

Your credit utilization ratio factors in around 30% of your credit score making it the second largest factor used in the calculation of your credit score. With that large portion of your credit score calculation at stake, you can likely see why it is important. Experts agree that for the optimal credit score, your credit utilization should fall between 10% and 30% (not in the 70% range in the above example). If your credit utilization is above 30%, lenders may view you as risky and you will probably face higher interest rates when applying for additional credit or a loan if you are approved. In the previously mentioned example, for you to have what is considered a low credit utilization rate, the amount owed on your cards would be less than $300. If your credit utilization rate is high, it is essential that you learn how to lower it while improving your credit score.

How Can You Lower Your Credit Utilization and Improve Your Credit Score

You can improve your credit utilization and by doing so improve your credit score. From the above examples you can see that lower credit utilization is the key to a higher credit score. An easy place to begin examining your credit utilization is by checking your credit report. Your credit report will list all of the credit card accounts you have along with the credit limits. If, by chance, the limits aren’t listed, you can check your credit card statements or call your credit card company for the limit. Once you have determined your credit utilization rate, you can begin your plan of reducing your rate to arrive at the ideal of 10% to 30% credit utilization.

Determine how much debt you need to pay off to get your credit utilization below the 30% mark and work to pay down your debt. If you can pay it off quickly without putting yourself in a bind, then do so; otherwise begin paying off your credit card debt with a little extra every month toward each balance and keep plugging away. You will see results. As your debt goes down so will your credit utilization ratio and you will notice that your credit score will begin to rise. Even if you pay off your credit card debt quickly, don’t expect to see a change in your credit score right away. Typically credit card companies report monthly to the credit bureaus, so it may take a bit of time to see your results. During the process check your credit score and report regularly to keep yourself encouraged and on the road to successfully lowering your debt-to-credit ratio. When you have reached your goal, be sure to continue to check credit scores to help you maintain low credit utilization.

By understanding and improving your credit utilization rate, you will find yourself well on the way to an improved credit score. Once you arrive under the 30% mark, keep it that way by making future purchases in cash or by only using your credit cards for amounts you know you will be able to pay when the statement comes each month. Just remember by lowering your credit utilization, you are raising your credit score and providing a more secure financial future for yourself and your family.

Joy Mali is an active blogger who is fond of writing articles on Finance and educating people to monitor their credit report on regular basis to minimize the risk of fraud. Follow her on Twitter to know more on understanding credit utilization.