What You Need to Know About Credit Utilization

by Ashley Wirgau

When working to build your credit, it is essential to have a firm grasp of your credit utilization and how it affects your overall score. This portion of financial fitness is often overlooked by consumers when applying for loans. Thankfully, though, this is one piece of the credit puzzle that is easily addressed. If your credit score is lower than you would like, take a moment to examine your current credit utilization to see if some small adjustments could make for substantial change.

Credit Utilization: What Is It?

Before we get into how to fix it, we must first understand what it is and how it is determined. Credit utilization is relatively self-explanatory as it speaks to the level at which you are currently using your available revolving lines of credit (typically credit cards). It is the ratio of these balances as compared to the current limits on these cards. For example, if you have a balance of $4,500 on a credit card with a $10,000 limit, your current utilization would be 45%. Take the current balance and divide it by the total limit, and then multiply the resulting number by 100. For those consumers using multiple cards, it is necessary to add up the cumulative balances across all cards and divide by the total combined credit limits.

Why Should I Care?

The short answer – because your loan officer cares. Your credit utilization rate actually has a significant impact on your credit. It can account for upwards of 30% of your overall score, a score that is one of the key factors in determining whether or not that mortgage or auto loan or home equity application is going to be approved. As a potential borrower, you must pay attention to the amount of credit you are using and how it relates to the total credit lines you have been afforded.

There is a common misconception that high spending on your trusty Visa or Mastercard helps increase credit scores. Unfortunately, if that spending is utilizing a high percentage of your total credit, you may be working against yourself. According to Experian, keeping a utilization rate of 30% or below is the preferred goal, while other sources suggest that 10% credit utilization is an optimum amount. Be careful not to push this too low, though, as credit cards that are not used at all may prove detrimental to your credit score.

How Can I Make It Work for Me?

There are multiple ways to manipulate your credit utilization and have it work in your favor, the most obvious being the difficult practice of self-discipline. Tracking your balances and keeping them within a desirable range is the number one way to maintain good credit utilization rates and show lenders that you are a safe bet. If this proves too difficult, as it does for many of us, you might arrange an auto-payment of your balance twice a month instead of the standard monthly bill pay. By breaking up the amount into two separate payments, your balance is kept at a lower rate for longer.

Another option for improving your utilization ratio is a quick call to your credit card company to ask for a balance increase, providing you are in a good financial position to make such a request. Remember, though, just because your credit limit is maximized does not mean your spending should change. The goal is low utilization on cards, and this is achieved with higher limits and lower balances.

Exercising self-control is in one’s best interest in nearly all areas of life, but especially when it comes to credit cards. Maintaining desirable utilization ratios on revolving lines of credit is an easy way to make a significant impact on your credit score. For those of you hoping to become happy new homeowners, it just might be the boost you need to get that approval stamp on your mortgage papers.

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