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Your credit utilization ratio is the ratio of debt to available credit that you have. It accounts for a significant amount of your FICO credit score. What we hope to do is clear up some misconceptions about credit utilization to help you mastering this import factor on your credit report.
What is Credit Utilization?
According to an interview with FICO spokesman Craig Watts published on Creditscoring.com, the actual percentage of your FICO score determined by your credit utilization varies. But Watts says — and a host of media outlets have reported — that this number accounts for about 30 % of the average person’s score.
The factors used to determine your credit utilization include:
- Total amount of debt
- Amount owed on specific types of accounts (i.e., revolving store credit cards, revolving major credit accounts, personal loans, mortgages, etc.)
- Lack of a specific type of balance, in some cases
- Number of accounts with balances
- Percentage of installment loan amounts owed based on original amount borrowed
- Proportion of balances to credit limits on revolving accounts
When most people think of their credit utilization ratio, they think of that last number — the amount of the balances they owe in proportion to their credit limits on revolving (credit card) accounts.
Let’s look at the other, lesser known, factors first.
Different Types of Debt
Of course, your total amount of debt factors into your score, although this is offset by the total amount of available credit. More importantly, banks want to see that you can handle different types of credit — for instance, revolving debt and a mortgage or car loan.
In fact, a 2:1 ratio of installment debt to revolving debt is most desirable to banks.
That doesn’t mean you should go invest in real estate or buy a new car just to add an installment loan to your credit history — but you can add your name to a spouse’s loan to benefit your credit score.
Managing your Ratio of Debt to Available Credit
Just as experts differ on how much of your credit score is affected by your credit utilization, they also disagree on how much debt-to-available credit you should have. And the suggested numbers range from “using no more than 75% of your available credit” to “using less than 30% of your available credit.”
So, who is right?
The vast majority of expert media sources agree that you should keep your total debt at or below about 30% of your total available credit. You shouldn’t “max out” one card, either — keep the balances distributed so that you don’t owe more than 50% of the total available credit on any one card.
Of course, if you recently bought a house or a car, there’s not much you can do about a high debt-to-available credit ratio on an installment loan. But you can follow these guidelines to help improve your credit score when you need to apply for new credit, like a home or auto loan.
How To Lower Your Debt-to-Available Credit Ratio
There are a few ways to lower your debt-to-available credit ratio and improve the credit utilization ratio portion of your FICO score.
1. Ask for a credit limit increase.
Credit limit increases are harder to come by these days, but if you’ve made on-time payments for the past 6 months to a year, you may be able to call your creditor and ask for a limit increase. Credit card companies are more likely to grant an increase if you are making a specific purchase. If you plan to make a big ticket purchase and have the cash available, call and ask for a credit limit increase to cover the purchase. Then pay off the purchase within the grace period for new purchases so you won’t pay interest. (Bonus: You’ll get extended warranty protection on the purchase with most credit cards).
2. Pay down your balances.
It may be desirable to pay off the lowest balance, highest interest card first, using the snowball technique to get out of debt. This is a good strategy, but if you have a card that’s very close to its credit limit, look for ways to pay down that card, too. You may consider transferring balances to a card with a higher credit limit.
Final Words & Next Steps
It’s a balancing act but, with careful credit management, you can increase your credit score with a good credit utilization ratio. And the great thing is that your credit utilization ratio is recalculated every month – so mastering it at any point in time will quickly improve your credit score.
Finally, if you want to learn more about mastering your credit score, check out this article on Factors Affecting Your Credit Score.