Worried about your credit utilization ratio? If you’re like most people, you probably don’t know what a credit utilization ratio is. But suppose you want to avoid getting denied for loans or other types of financing in the future. In that case, it’s important that you understand this number and how it affects your finances.
Here are 10 smart moves to lower your credit utilization ratio so that lenders will be more likely to approve your loan applications in the future!
Read on below for tips on how to reduce/lower your credit utilization ratio.
- What is a credit utilization ratio?
- Why does your credit utilization ratio matter?
- How is the credit utilization ratio calculated?
- What can I do to lower my credit utilization ratio?
- Final Thought
What is a credit utilization ratio?
When lenders look at your credit report, they typically consider the total amount of debt you owe compared to your total credit limit(s). This ratio is your credit utilization ratio. For example, if you have 5 credit cards with a combined balance of $10,000 and a combined maximum limit of $50,000, then your credit utilization ratio would be 20%.
Why does your credit utilization ratio matter?
Your credit utilization ratio is one of the factors that lenders will look at when approving or denying your loan request(s). Suppose you have a higher percentage (such as 20% in the example above). In that case, it could negatively impact your chances of getting approved for additional financings, such as an auto or home loan.
That’s because even if you can afford to make payments on multiple loans, banks normally like their borrowers to use only a small portion of their available credit at any given time (i.e., less than 10%, but 3-6% is generally preferable).
How is the credit utilization ratio calculated?
Your credit utilization ratio is calculated by dividing the total amount of debt you owe by your total available credit.
So if you have 5 credit cards with a combined balance of $10,000 and a combined maximum limit of $50,000, that would mean that your credit utilization ratio would be 20%.
The general rule of thumb is that you should try to keep your credit utilization ratio to 30% or lower. But suppose you have an excellent credit score. In that case, most lenders will consider providing financing with a higher debt-to-available credit ratio.
As per Experian statics: A score of 660 and higher: Lenders may approve your loan application with a high credit utilization ratio – up to 50% or more.
The Experian study also showed that consumers who carry a balance on their credit cards are $998.4 billion compared to those who pay in full every month, which is only 21 million.
Read More: What is a Good Credit Score in 2021?
What can I do to lower my credit utilization ratio?
Suppose you think that your credit utilization ratio is too high. In that case, there are several ways to lower the total amount of debt you owe. Below are some of them.
1. Pay off your debts!
The obvious first step is to pay down open balances on your credit cards and other loans. The less debt you owe, the lower your credit utilization ratio should be (assuming that you don’t go out and charge up lots of new debt).
However, a word of caution: To avoid a situation where you’re paying more in interest than what you originally borrowed, it’s very important not to simply transfer balances from credit cards to loans. If possible, pay off your debts using cash flow or other sources of income instead.
2. Get another loan!
If you have good credit and looking for a way to save money, consider applying for a personal loan. They aren’t as easy to get as credit cards – especially if you have a less-than-stellar credit score – but these loans can be very helpful in paying off existing debts and lowering your overall debt ratio.
For example, if you have $5,000 left on a personal loan at an interest rate of 4%, it would take about 12 years to pay off that balance with just minimum monthly payments! However, by taking out another personal loan at the same annual interest rate, but this time with a balance of $12,500 spread across 3 years, it will only take 7 years and 3 months before you pay off the entire amount.
3. Be smart about your new lofty credit limits!
Suppose you’re approved for financing with a high value, such as taking out $30,000 on loan. In that case, it’s important to understand that some lenders will report this large amount as “new debt” to the credit bureaus. This can significantly impact your score and make it more difficult to qualify for future loans and lines of credit (including things like mortgages and business funding).
4. Try another avenue first: If all else fails…
If you need additional funds – and pay off the balances in full each month – what happens when you apply for an auto or personal loan? The bank will look at your total available credit (not just how much you owe), which could either increase or decrease your credit utilization ratio.
Don’t be surprised if you’re approved for a loan with an extremely high amount of available credit, but then find that you can’t get financing for anything else because your overall “credit capacity” is already over the limit!
It’s worth noting also that closing existing lines of credit can sometimes hurt your score. To minimize this effect, try not to close accounts will high balances unless it makes sense financially.
For example, you might want to keep your mortgage open even after selling the property if it has a balance that’s below $50K or so. Similarly, there’s no reason to cancel an old line of credit just because its minimum monthly payment exceeds the needed payment.5. Don’t close an old card if you expect to return it to its original use!
As you’ve learned so far, closing accounts can hurt your score. However, suppose you’re planning on returning that account to use shortly (such as re-applying for credit). In that case, there’s no need to cancel the card.
Just remember that it will take some time for this information to age off of your report, so don’t forget about your plans for this particular card just because you “closed” it at some point in the past!
5. Be careful with balance transfers!
What happens when you transfer balances from one credit card to another? Although most people understand how applying for new credit can hurt their score, many do not know that balance transfers are looked upon just as unfavorably by the bureaus.
However, the good news is that if you plan to keep your balances low or pay them off in full each month, there’s no reason to be concerned about doing this. In fact, because transferring existing debt from one card to another can reduce your overall debt ratio (assuming you don’t charge anything else during this time), it may actually increase your credit scores!
The key here is to simply make sure that you follow through with paying off those debts before applying for any other type of financing – including things like home mortgages and car loans. Only then will you see the benefits of a low credit utilization ratio … while boosting your chances for approval on new loans and lines of credit.
6. Be careful with private student loans!
If you’re in the market for a private student loan, be sure that you understand what’s being reported to the bureaus before signing any contracts or other documents. Although these particular loans do not count towards the FICO® score, they still affect your overall credit utilization ratio.
For example, suppose you need additional funds to pay off a large debt from current college expenses. In that case, a personal loan could make more sense than a private student loan because it can lower your balance-to-available-credit ratio (which is how this information is reported). But again, if you need to charge anything else, this could backfire and dig you into a deeper debt hole.
That’s why it’s important to ensure that your credit utilization ratio is as low as possible – ideally at or below 30 percent – before taking on any additional debt (student loan or otherwise).
7. Don’t forget about installment loans.
They matter too! Installment loans (including car and personal loans) can help increase your overall credit score by adding positive information to your history. For example, suppose you’ve been borrowing money for years against the same asset (such as a car). In that case, there’s less risk associated with loaning the same amount of money again. The opposite holds true if you’re constantly borrowing and repaying loans for things like furniture, appliances, etc. In short, you’re demonstrating that you’re a reliable borrower … as long as you actually pay for those items! The problem is that many people just put these expenses on credit cards or other revolving balances because it’s easier to repay them later.
That said, if you charge a large amount of non-recurring purchases (such as a car loan), then the lender may report this information to the bureaus much earlier than your personal finance habits would suggest. This can have negative consequences in the form of lower credit scores even if you’ve been careful about how much debt you carry month to month.
8. Just be smart about how much credit exposure you take on.
If you’re just starting out, then don’t worry too much about these points. The most important thing for most people with no credit history is to have some positive information on file with the bureaus. So use your credit cards sparingly at first and pay off any balances in full each month so that future lenders can see what type of borrower you are.
Eventually, you’ll reach a point where every hard inquiry will affect your score negatively – whether they come from opening new accounts or transferring existing debt onto new cards.
This means that things like balance transfers should be avoided unless necessary because they could lower FICO scores. It also means that having lots of open accounts is not always better than having few accounts containing significant balances (e.g., a mortgage, student loan, and car loan). In fact, having too many open accounts could trigger what’s known as the “FICO score trap” – a situation where your scores have little room to improve even though you’ve been practicing smart financial habits.
The best way to avoid this particular pitfall is to manage all of the credit cards in your wallet so that it reflects a consistent payment history throughout each year. Suppose there are any new accounts or other changes. In that case, those new items should be combined into one period of time (e.g., from Jan 1-Dec 31) before being distributed across multiple periods (e.g., from Dec 28 – Mar 12).
9. Avoid carrying more than one balance.
Ideally, you should pay off your entire month-to-month balance by your credit card payment due date. That way, any accrued interest fees will be charged to the issuer and not to you. You can still increase your credit score this way even if you have more than one line of credit because it suggests that you’re responsible for handling debt!
Suppose you find yourself needing additional funds to cover unexpected expenses during a particular billing cycle. In that case, there are creative ways that can help improve your situation. For example, cash advances are usually only subject to the standard daily interest rate but won’t impact any future balances or reimbursements until an unpaid cash advance is either repaid in full or rolled over into another monthly expense. This means that there’s no need to worry about additional interest fees until you’ve taken care of the current month-to-month balance.
Just be sure not to create a new charging habit because the resulting expenses may too much affect your overall utilization ratio. In other words, keep track of how much you’re borrowing from each account and only use cash advances as a last resort!
10. Request for a higher credit limit.
Suppose you have a good payment history with your current card issuer. In that case, chances are that an existing creditor will try to support your efforts. They may even offer you the opportunity to request higher credit limits so that you can generate better repayment habits without being forced into debt!
If you’ve already established strong payment history, then be sure to ask for credit limits that are equal to your total monthly income (e.g., take-home pay + any employer bonuses). Otherwise, you may be unnecessarily prolonging the time it takes for your balances to drop below 30% of your credit limit. This practice could negatively affect your FICO score because it may suggest that you’re just becoming more comfortable with having high levels of credit card debt.
The credit utilization ratio is one of the most important factors in your credit score. When you don’t have a lot of debt, it can be tempting to take on more and try to “make up” for lost time, but this will only make things worse. To keep your credit healthy without adding too much additional risk or stress, follow these 10 smart moves. Do any apply to you? If all else fails, consider another avenue before taking on yet more high-interest rate debt!
If you have any more questions, feel free to let me know! Please share if you liked this post! Thank You for reading, and I hope that these tips were helpful in some way.
Frequently Asked Questions about ways to lower credit utilization ratio.
My credit card is maxed out, and I’m struggling to keep up. What should I do?
If you’re having trouble keeping up with your current payments, then there are two important things that you need to do.
First, negotiate a higher credit limit. This should be very easy for you to do because you’ve already established a good history of paying bills on time. Just call the credit card company and ask to have your credit limit increased. If you’re approved, then it will be much easier for you to meet the monthly payments.
Second, pay off your credit card balance faster. If you can increase your payments by $100 per month, it should only take two years to pay the entire account off. Just be sure that you don’t add more expenses if you can’t afford it yet because your goal is to reduce the utilization ratio as quickly as possible.
Is it okay to carry a balance on my credit card if the interest rate is low?
Ideally, you should plan to pay off your current credit card balance as quickly as possible. However, if it makes sense for you to carry a balance, then it may be okay to do so. Just know that the longer you hold onto this debt, the more additional interest fees you’re likely to accumulate.
This makes it more difficult for you to lower your utilization ratio because it’s calculated as a total debt divided by the total credit limit.
In other words, if you’re carrying a balance of $5,000 and your credit card limit is only $2,500, then this suggests that your utilization ratio is 50%. If, instead, you’re carrying a balance of $2,500 and your credit limit is $5,000, then this suggests that your utilization ratio is 40%.
The lower the number, the better you appear to creditors and other credit scores. Since you want to aim for the lowest possible score, paying off credit card debt as quickly as possible may make sense.
How do I check my credit utilization ratio?
You can find information about your utilization ratio on your personal credit report. Suppose you haven’t checked this information recently. In that case, you should do so because there’s a good chance that it’s different from the number that creditors use when they review your account.
You can access your credit report and FICO scores for free on Credit.com. This makes it easy to review your history and figure out how best to improve your credit in the future.
How do I keep my credit card load low?
Your credit utilization ratio can be affected by many factors. For example, if you pay off a large balance each month, this will reduce your total debt. However, take on new high-interest rate debt to cover the difference.
This will leave your credit utilization ratio unchanged at best. In other words, you need to be careful about your purchases because they can have a significant impact on this number.
Do you know any tips to help lower the credit utilization ratio on my credit cards?
Absolutely. If you have a lot of credit card debt, you should work to reduce this burden as quickly as possible because it will help your overall credit score. You can accomplish this by following the steps described above. Just be sure that you don’t compromise your financial security to save some money on interest fees.
In addition, you may want to talk to a counselor or debt management company. These professionals can review your personal situation and help you make a plan for paying off your credit card debts in the most financially responsible way possible.
Why is my score still low?
You would probably be disappointed if you discovered that someone had been keeping information from you, but there are also plenty of good reasons for encouraging you to review your credit report and FICO scores.
One reason is that this information will help you stay on track financially, which can prevent you from making unnecessary and expensive purchases because it makes you aware of the amount of debt you’re taking on.
When we look at the data in aggregate, we can see that people who pay off their balance in full each month have the highest credit scores. However, suppose you choose to carry a balance on your credit card. In that case, it’s important to keep this ratio low because it makes your overall financial picture look better.
Does a credit card debt settlement affect a credit score?
If you’re struggling with credit card debt, you must review your options when searching for a solution. This is especially true if you want to avoid taking on additional interest fees and other costs in the future. If this is the case, you may be able to lower your utilization ratio and improve your credit history by filing for bankruptcy.
How does bankruptcy affect my credit?
If you go through chapter 7 or 13 bankruptcy, this will be listed on your credit report for about ten years after the debt was discharged. One way to prevent this from hurting your credit score is by taking on debt management services before you go through bankruptcy.
These professionals will negotiate with creditors on your behalf and help you repay some or all of your outstanding debts in affordable monthly payments based on your income level.
Can lowering your credit utilization raise my score?
It is possible to raise your score by paying off debt, but it’s more likely that you’ll see a significant boost in your credit score through the use of smart money management techniques.
You can do this by making all of your monthly payments on time and following other best practices when managing your personal finances.
Is 40% credit utilization bad?
40% credit utilization is fairly high in comparison to the recommended percentage. If you have a total balance of $2,000 on two cards with limits of $5,000 each, then your ratio will be at 40 percent.
This means that your overall score may drop when creditors review it because they look for borrowers’ financial responsibility.
Why is high credit utilization bad?
Having a high credit utilization ratio is bad because it demonstrates that you may be in financial trouble and not repay your debts.
This means that creditors will also be more likely to deny your application for new credit, such as an auto loan or mortgage, due to the risk that you could run into similar problems when repaying this debt.
What should your credit utilization be to buy a house?
Your credit utilization is one of the most important factors that creditors determine whether or not to issue a loan.
This means that it’s possible for people with bad credit scores to still be approved if they have low ratios because this shows they are financially responsible and capable of repaying their debts.
How much will lowering credit utilization affect the score?
It depends on how much you owe in credit card debt. If your balance is higher, then it will have an even bigger impact on your score.
One general rule of thumb is that the lower your utilization ratio, the better off you are financial. This demonstrates that you’re able to manage your finances responsibly.