Is your credit score as high as you’d like? If it is a work in progress, we are here to help. We are continuing our Boost Your Credit Series. In this monthly series, we provide you easy tips for improving your credit. To kick things off, last month you just had to get your credit report and score. Now that you have your report in hand, it’s time to get to work. This month we will tackle your credit utilization ratio.
What is a credit utilization ratio?
Your credit utilization ratio is simply the amount of money you owe compared to the amount of total credit you have. For example if you owe $5,000 and your total credit limits are $10,000 then your credit utilization ratio is equal to 50%. The closer you are to your limits, the higher your ratio will be.
How much of an impact does my ratio have on my overall score?
Your credit utilization score which represents the amounts you owe affects 30% of your credit score. This is the second most important factor in your overall score. It is also the easiest and fastest way you can improve your score.
What is a good ratio?
Unlike your overall credit score where higher is better, with your credit utilization ratio lower is better. Credit experts generally agree that ratios should ideally be under 35 percent. And studies have shown that those with the best credit have ratios under 20%.
There are two ways to improve your credit utilization ratio, either pay off debt or increase your limits. Each method has its own pros and cons.
How do I pay off debt to improve my ratio?
You can’t simply just pay more on all your accounts and expect to have a dramatic impact on your ratio. You have to be strategic. You should aim to pay off the balances on the cards and accounts with the lowest limits. For example if you pay an extra $200 on an account with a $10,000 limit, that doesn’t have a big impact. However, if you pay an extra $200 on an account with an $800 limit, you have dramatically decreased your utilization ratio for that card. You will find store credit cards are generally the ones with the lower limits and general credit cards like Visa and MasterCard have the higher limits. So start paying down the store cards first.
After I pay off cards, should I close my account?
It feels great to pay off a debt and be rid of it. Many want to get ultimate closure and actually close their paid off accounts. This may be good for your soul but not for your ratio. When you close the account, you lose your 0% ratio which is the best ratio to have.
What about increasing my credit limit to improve my ratio?
Another way to improve your ratio is to increase your limit. So instead of owing $2,000 on a $3,000 limit and having a 66% ratio, you can increase your limit to $4,000 and drop your ratio to 50%. This sounds like a good tactic but most people end up charging even more and their ratio goes back to where they started and now owe more. And in this day and age, credit companies are very reluctant to give out more credit. So the best way to improve your ratio is to simply pay down debt.