Understanding The Aspects Of Credit Utilization Ratio

How important is it to maintain a Good credit score? Very!

You have probably heard that your credit utilization ratio plays a huge role in the rise and fall of your credit score. It helps you determine how much of your credit you are using. The general rule of thumb is that your credit utilization ratio should not be more than 35%. 

According to a study by FICO, people with high credit scores above 750 can maintain a credit utilization ratio of 10%. This percentage is updated monthly, so you can start managing it now.

Here’s an example to help you understand how your credit utilization ratio is calculated:

To find your credit utilization ratio, divide the total balance by the total credit limit and multiply what you get by 100.

$4,900 / $22,000 = 0.22 x 100 = 22%

Overall vs. Per-Card Utilization

Per-card utilization is as important as overall utilization. When your credit score is calculated, all accounts are considered. For example, let’s say you have two credit cards. 

The credit utilization ratio on one card is 40%. You get a new card with a $0 balance, thinking it will help you lower the percentage. While the new card might lower your credit utilization ratio by a small margin, the balance on the old one will still affect your credit score.

You are misguided if you think closing a credit card will help you with this. By closing a card, you will lower your credit limit. Since you will still have to pay the debt, the credit utilization ratio will increase.

For example, you have two credit cards with $20,000 in credit. The limit on each card is $10,000. You use one card’s entire credit limit, meaning your credit utilization ratio is 50%. 

You then decide to close the credit card with $0, lowering your overall credit limit to $10,000. Since you have used this amount, your credit utilization ratio is 100%.

Transferring Balance 

Transferring your balance to a 0% interest rate card will not change your credit utilization ratio. However, it can help you get out of debt faster and improve your credit score. 

Since the balance will be transferred to another card, you can pay it off in smaller monthly payments. This is not a good option if you already own more than two credit cards. 

Banks make a hard inquiry into your credit report to determine if you can afford another credit card. This lowers your credit score by 5% to 10%. This might seem small, but the more cards you open, the more inquiries will be made.

Having a 0% credit utilization ratio is not the answer to remaining debt-free. This ratio is what helps lenders decide whether you can manage your finances or not. 

Unless you have a credit history to show how good you are with your money, how do you expect a lender to give you a loan? So, use the credit card wisely and keep the credit utilization ratio below 35%.