It’s crucial for consumers who use credit cards to increase their financial literacy. Knowing how a credit limit can impact credit scores can help you build a good credit score! If you are new to credit cards, you may wonder, “What is credit utilization?” Learn what credit utilization is and how you can obtain a good credit utilization ratio!
What Is Credit Utilization and Why Is It Important?
Credit utilization is the difference between how much available credit a consumer has compared to their credit limits. Borrowers can and should use credit cards, but maxing out your credit card accounts can have negative repercussions on your finances and credit rating.
Most credit scores are affected by your current credit card balances. Using a majority of your credit limits will result in a high credit utilization ratio, which will negatively affect your credit score and qualification for loans. But maintaining a low credit utilization rate can help you obtain an excellent credit score.
Many financial institutions use FICO scores, which are calculated using these five factors:
- Payment History – 35%
- Amounts Owed – 30%
- Length of Credit History – 15%
- New Credit Inquiries – 10%
- Credit Mix – 10%
As you can see, credit card usage affects your FICO score by 30%. Paying down your credit card debt should be a top priority if you want to improve a bad credit score.
How Much of My Credit Limit Should I Use?
Now that you know credit card usage can directly affect your credit rating, you may wonder how much money you can spend with your credit card. Many financial experts advise credit card users to avoid using more than 30% of their total available credit. Using more than 30% of your combined credit limits can decrease your credit score and make it harder for you to qualify for emergency funding.
An agent will analyze your credit report when you apply for funding with a lender or credit card issuer. Your current financial accounts and your total debt will be visible. Carrying too much credit card debt signifies to a lender that you have trouble managing your finances. Consumers deemed to be a high credit risk will have difficulty getting approval or affordable loan terms.
But individuals with low outstanding balances typically receive the best loan offers and interest rates! Lenders may feel confident extending a higher credit limit or loan amount because you demonstrate financial responsibility.
How To Calculate My Credit Utilization Ratio
A low credit utilization rate is the key to getting a healthy credit rating. But how can credit card users check their credit utilization ratios?
To calculate your credit utilization rate, you need to know your total current balances and total credit card limits. Once you have your balance and credit limit information, divide your total credit card debt by your total credit limit. Then multiply your answer by 100 to get your credit utilization rate as a percentage.
Suppose you have three credit cards:
- Card 1 – $1,200 balance with a $3,000 limit.
- Card 2 – $800 balance with a $1,500 limit.
- Card 3 – $200 balance with a $2,000 limit.
According to the information above, your total outstanding credit card balance is $2,200, and your total spending limit is $6,500. When you divide the overall balance by the overall limit, you get 0.33846. Multiplying 0.33846 by 100 results in 33.846%, which is higher than the recommended 30% utilization ratio.
Suppose you want to improve a bad credit score. In that case, it’s imperative that you focus on paying off your credit cards to get a low credit utilization ratio. Paying down your credit cards can improve your finances as well as your credit health. Credit cards tend to have higher than average interest rates, which can result in significant financial loss to borrowers with high balances. The less debt you have, the more money you can keep in your pocket!
Can I Increase My Total Credit Limit?
A credit limit increase can lower a borrower’s credit utilization ratio and improve their credit! Credit card companies tend to offer limit increases at least once a month if the borrower displays good financial habits. If you have been using your credit card for a few months and have not received an increase, you can take the initiative and ask for a higher spending limit.
To raise your current credit limit, you can call customer service and directly ask for a credit line increase. The customer service agent will pull up your credit card account information, and they may ask you for additional details. You will either get a credit limit increase or a polite “No.”
You stand a good chance of getting a higher credit limit if you meet one of the following criteria:
Your Income Has Increased
When your income increases, many credit card issuers are willing to increase your available credit. Earning more money means you are able to make costlier purchases and still make reliable monthly payments. When you speak to a customer service agent, inform them that you need to update your income information. Even if you do not receive an increase now, your credit card issuer may provide one later.
Your Credit Score Has Improved
If your credit score has improved since you applied for the credit card, you stand a good chance of getting a limit increase! Obtaining a higher credit score shows that you have control over your spending habits and a history of making good financial decisions.
If your score went up by a lot of points, consider also asking about upgrading to a rewards card. A rewards card is a credit card that offers cash back, points, or travel miles for every dollar you spend. You could end up getting substantial rewards for using your card on everyday purchases!
Your Payment History Is Reliable
Paying all your installment loans and credit cards on time can help you get a better credit score and higher credit limit! Payment history is typically the most critical factor for credit score calculation since lenders need assurance of repayment. When lenders report to credit reporting agencies about your reliable monthly payments, you can expect a credit score boost! Use your excellent payment history as leverage to get more spending money.
Additional Ways To Keep Your Credit Utilization Low
If a credit card company does not give you a credit limit increase, do not worry! There are alternative methods to keep your credit utilization ratio low. Learn how to control your finances better and improve your credit score below.
Pay off Purchases Immediately
If you want to decrease your utilization ratio, then it’s essential that you stop increasing your current balance. You should reconsider the transaction if you cannot afford the purchase right now without installments. So what happens if you want to use your credit card for rewards?
Credit card rewards can help you get extra money for spending, so it’s worth using your card to make purchases. But staying on top of your bills can prevent further debt. Swipe your credit card and then pay off your purchase before the end of the billing cycle! Carrying a balance means paying interest charges and increasing your credit usage. But by using your credit card and paying purchases immediately, you can get rewards and lower your overall credit usage!
Make Multiple Monthly Payments
If you have money left over after your monthly bills are paid, consider making an additional credit card payment! Most credit card issuers do not limit the number of payments you can make in a month. Making more than one monthly payment can help you speed up the repayment date of your credit card and help you avoid costly interest fees! Decreasing the amount of credit card debt you have will reflect positively on your credit rating.
Keep Credit Accounts Open
Closing a credit card account may seem like a great choice when you’re trying to improve your credit score. Still, it can actually cause a negative effect. When you close a credit account, you decrease your total credit limit and raise your credit utilization rate.
Once you have paid off a credit card, it’s best to leave it alone! You do not have to use your credit accounts once you finish paying off your current balance. However, keep in mind that credit card companies may close your account without notice if you don’t use the account for a prolonged period. Contact your credit card issuer to ask about account closures.
The Bottom Line: Credit Utilization
Credit utilization is the sum of your credit card balances divided by your total credit limits. Using more than 30% of your available credit can negatively affect your budget, credit, and financial opportunities. Too much credit card debt can prevent you from improving your credit score and cost you a lot in interest fees.
If you want to make the most of your money and save, know that paying down your credit cards is the key! Budgeting is the best way to pay off your credit card balances quickly. Saving money each month allows you to make higher monthly payments, which can speed up the repayment process. Evaluate your finances and keep track of spending to save big.
References:
What is a Credit Utilization Rate?│Experian