Welcome back to the second article in this series about your financial health and wellness. Last time we talked all about credit scores. We covered what a credit score is, why it is important and how to improve your credit score. In this article, you will learn about one of the important numbers that affects your credit score: credit utilization ratio. You will learn what credit utilization means, how it can affect your credit score and some tips to keep your credit utilization at a healthy level.
First, an explanation of what exactly credit utilization ratio means. Simply put, it is the amount of your available credit that you are actually using. Say, for example, you have one credit card with a $1,000 limit. Your outstanding balance, or the amount you have charged, is $500. All you have to do to figure your credit utilization on this card is divide the balance ($500) by the limit ($1,000) and multiply by 100.
In this case, the credit utilization ratio is 50 percent. The scenario above is called the per card credit utilization ratio. What if you have more than one card? That is easy, too. If you have more than one card, you need to know your overall credit utilization ratio. Again, it is a simple calculation. Add up the credit limit of each credit card, then add up the outstanding balances of the cards. Divide the total balance by the total limit.
Let’s look at an example. Assume you have three credit cards. Credit Card A has a credit limit in the amount of $1,000 and the balance is $500. Credit Card B has a limit of $3,000 and a balance of $250. Credit Card C has a limit of $750 and is maxed out, meaning the balance is $750. What is the per card utilization ratio? And what is the overall utilization ratio?
Now that you understand how to calculate your credit utilization ratio, you can use this information to your advantage. The most important thing to know is that the credit scoring agencies look at both per card and overall ratios; one is not more important than the other. Also, this ratio factors heavily in determining your credit score. The lower your credit utilization ratio is, the more attractive you are to lenders. What is a good ratio? Anything under 30 percent is considered good. The lower your credit utilization ratio is, the better.
Looking at the scenario in the chart on the previous page, the overall credit utilization ratio is barely above 30 percent, which is pretty good. However, two of the individual cards are considerably higher at 50 percent and 100 percent. What can you do to improve your ratio? Three simple things: do not use the cards with the higher ratios (if you can stop using the cards altogether, even better); pay the minimum balance on two of the cards; and work on getting the third one down to at least 30 percent. In this case, you would need to reduce the balance of Credit Card.
A by $200 to 30 percent and reduce the balance of Credit Card B by $525 to get to 30 percent.
Lastly, how can you prevent yourself from going over the 30 percent threshold? Most credit card companies offer text alerts that you can set up online. You can set up a text message to alert you when you have reached 25 percent of your limit so that you know when to ease up on spending for that particular card. Another option is to ask for a credit limit increase. If you decide to exercise this option, just know that it is considered an inquiry on your credit and will cause your credit score to drop temporarily.
The best option to improve your credit and decrease your credit utilization ratio is to stop using credit cards and to pay off your debts. You may not think this is a good option for you right now. However, learning about your cash flow and creating a spending plan for your family can do wonders for your credit, your wallet and your financial health and well-being.
Now you know how to get your credit score and a copy of your credit report, how to calculate your credit utilization ratio and how to improve both. In the next issue of Journey, we will learn all about the debt to income ratio and how it is used to determine if you will qualify for a mortgage.