By Mihika Ghosh
Special to the Financial Independence Hub
Credit agencies use the credit utilization ratio to understand your credit score. The credit utilization ratio is your total credit to your total debt amount expressed in a percentage format. In simpler terms, it refers to the amount of debt you carry in all your credit cards.
Your credit utilization ratio increases and decreases based on the payments and purchases you make. It is one of the factors that help credit bureaus calculate a credit score and makes up 30% of your credit score. Hence, it is vital to keep your credit utilization ratio as low as possible to avoid debts and maintain good credit scores.
Why does your Credit Utilization Ratio matter?
A high credit ratio negatively impacts your credit score rating process and indicates that the borrower is not great at managing their credit. At the same time, a low credit ratio implies excellent credit management skills.
There are two important factors in maintaining a good credit score – first is your payment history. Late payments and abundant due payments can negatively impact your credit score. The second factor that lays of great importance is your credit utilization ratio. If you are trying to land in the good books of the lender, you need to build good credit by keeping your credit ratio as low as possible.
Most credit experts recommend you keep your credit ratio below 30% to maintain a good credit balance.
How to Calculate your Credit Utilization Ratio
First and foremost, start by pulling up all your credit cards together, then add up all of your outstanding balances along with your credit limits. Take this figure and then divide it by your total credit limit and multiply it by 100. Your answer will be your total credit utilization ratio which will come out in percentage.
Note that your credit ratio is not the sum total of each of your credit card’s credit utilization ratios. Hence, it is important to calculate the total credit of all your credit cards.
However, if this calculation method is still too complicated for you, or you would just want to let calculators do the math, there are plenty of online credit utilization calculators that can assist you.
How to Improve your Credit Utilization Ratio
Lowering your credit utilization ratio is easy and one of the quickest ways to boost your credit score. Here are a few ways in which you can get started:
- Pay All Your Debts
The best way to improve your credit ratio is by paying off any pending credit card balances. Every dollar you pay reduces your credit ratio and total debts, in turn getting you one step closer to a good credit utilization ratio. This even reduces the baggage of interest you had to pay on those balances.
- Ask for Higher Credit Limit
When you ask your credit card issuer to increase the credit limit, more credit gets available in your account, lowering your credit utilization ratio. But before you do that, ensure that you are not digging a hole for yourself by making this higher limit credit card another means of debt!c
- Apply for another Credit Card
Having multiple credit cards issued in your account increases the amount of credit that will be made available to you. If you do not increase your overall spending with these cards, you will see a decrease in your credit utilization ratio. Moreover, a new card means added credit card rewards, bonuses, and other perks associated with it!
- Setting Balance Alerts
If you have issues managing your credit, you will find it effective to set up balance alerts by contacting your credit card issuer. They can sign you up to receive alerts when your credit utilization ratio reaches a certain point.
Your credit utilization ratio acts as a major factor behind maintaining a good credit score, and additionally, it is a lot easier to lower this ratio. So try your best and keep it as low as possible to leverage many connected advantages.
A finance enthusiast, Mihika Ghosh works as a Digital Content Creator at Fit.Credit, an all-in-one app that helps you check your credit score for free, stores your financial documents, and gives you timely payment reminders. She creates content that educates people on how they can improve their credit scores along with other investment and finance-related topics. When she is not working, she loves to travel and read to keep up with all things finance and economics.