Let’s face it; nobody has ever taught us about credit utilization ratios. Having good credit is essential to many areas of our life, from getting a mortgage or a car loan, to renting an apartment or applying for a new job. Here’s a guide that will help you to understand what a credit utilization ratio is and to learn how to manage it effectively.
What is Credit Utilization Ratio?
First things first, credit utilization is the percentage of credit you are using in comparison to your total available credit. For instance, if your credit card limit is $20,000 and you owe $3,000, then your credit utilization is 15%. It is important to keep credit card utilization to a minimum because the higher the rate, the more it will negatively affect your credit score, making it more difficult to obtain credit or loans.
Why is Credit Utilization Ratio Important?
The explanation to why credit utilization is important is quite simple. Most lenders and credit bureaus believe that people with high credit utilization ratios are more likely to default on their debts than those with low ratios. That means that if you, for instance, max out your credit cards, you might be seen as a high-risk borrower.
How is Credit Utilization Ratio Calculated?
You just need two numbers to calculate your credit utilization ratio: your outstanding balance and your credit limit. You should take your current balance and divide it by your total credit limit. The result will be the percentage of credit you have utilized.
What is the Ideal Credit Utilization Ratio?
The ideal credit utilization ratio is below 30%. A ratio within 0 and 30 percent percentage indicates that you’re employing your credit but not too recklessly. On the other hand, a utilization percentage of over 30% means that you might be spending too high on your card, causing creditors to consider you as a higher risk.
What Happens if You Exceed Your Credit Limit?
If you surpass your credit limit, the borrower usually bills an over-limit fee. However, surpassing such limits has more significant consequences for your credit score, as it is seen as a sign of lack of accountability in managing finances.
How Can You Improve Your Credit Utilization Ratio?
There are a few practical ways to improve your credit utilization ratio. First, pay down your credit card balances preferably until they are under 30% of your limit. You can also ask your credit card issuer to raise your credit limit, which can automatically decrease your ratio. Additionally, you can request a new credit card but not use the additional limit as an excuse to spend more.
What Should You Do If You Have a High Credit Utilization Ratio?
If you have a higher credit utilization ratio than advised, it would be best to stop using your credit cards until you have your balance within your desired range. You can create a debt repayment plan to reduce credit card debt and to pay down your balances quickly.
What are the Consequences of a Poor Credit Utilization Ratio?
A poor credit utilization ratio can adversely affect credit scores and might lessen the chances of getting approved for new credit or for additional loans on favorable terms. Credit card companies could also lessen credit limits, add extra fees and interest rates to the credit card account balance. In worst-case scenarios, with a lower credit score, creditors could deny credit applications entirely.
How Often Should You Check Your Credit Utilization Ratio?
You should check your credit utilization ratio every month to maintain or achieve healthy credit. Reviewing your credit reports often and using an online credit monitoring tool may help keep you informed of changes to your credit utilization ratio that could trigger credit score damage.
Conclusion
A credit utilization ratio is one of the most crucial factors that determine your credit score. By reducing your balances and asking for a credit limit increase, you will help improve your credit utilization ratio, boost your credit score, and present yourself to prospective lenders as a safe borrower. Follow the recommended guidelines to maintain and establish healthy credit utilization.
