There are five factors that are calculated into your credit score: Payment History, Utilization Ratio, Length of Credit History, New Credit, and Credit Mix. Today, we are going to focus on Utilization Ratio.
Your Utilization Ratio accounts for about 1/3 of your overall FICO score – so it is important that you understand what it is and how you can improve it.
Your Utilization Ratio, also commonly called “amounts owed”, is a measure of how high your balances are compared to your credit limit. In other words, it is a snapshot of how maxed out your lines of credit are.
Your Utilization Ratio is recalculated each month when your creditors report your new balances to the credit reporting companies. Usually, they report whatever your last statement balance was, but the date they report it may be different than your statement ending date.
In general, the lower your balances are, the better off you are. That goes for both revolving accounts like credit cards and installment loans, like auto loans, student loans, and mortgages. Your balances are averaged over all your accounts, so if you have several accounts with low balances, one high balance will not tank your Utilization Ratio score.
Of the five components of your credit score, you have the most direct control over two of them – Utilization Ratio and Payment History. (To learn more about Payment History, read this.)
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Here are our top tips for improving your Utilization Ratio:
1. Aim to keep your credit card balances low.
We recommend your balances average out to no more than 7% of your credit limit for credit cards. So, if you have a total combined credit limit of $1000, you should strive to keep your balance lower than $70. For every additional $1000 in credit limit, you add another $70. Following this guide, if you have a total of 4 credit cards that add up to a $5000 credit limit, you should get your balances down to a total of no more than $350 across all the cards.
Need a plan to get your balances that low? Try this debt reduction method called a debt snowball.
2. Make all your installment loan payments on time
Installment loans, like auto loans and mortgages, start out with very high balances. As you make your regular payments on time each month, that balance goes down at a predictable rate. Keep up with that expected rate, and you will be okay.
And here’s a great trick to help you pay off our installment loans faster… Take your monthly payment amount and divide it by 12. Add that amount to your regular payment and make this your new payment. (Just be sure to tell your lender that the extra amount should go towards the principle, not accumulated interest.) Over the period of a year, you will make the equivalent of one whole extra payment, paying down your balance 5 (or more) years earlier and save thousands on interest.
3. Make more than one payment a month
There is nothing magical about your payment due date – except that if you miss it, you’ll be in trouble. Since lenders do not have a specific date on which they are required to report the credit reporting companies, it is in your best interest to make two (or more) payments a month. That way, no matter what day of the month they do report, you will have made a payment recently and your reported balance will a bit lower.
This is a very important tactic if you use your credit card for a big purchase, like a new washing machine or an expensive car repair. Start making payments towards that balance right away. Remember, your creditors report a snapshot of whatever your balance is on one specific day. If you charge $780 on Tuesday, and they report on Wednesday, you’re stuck with that high balance on your credit report for an entire month, even of you pay it all off Thursday that same week.
4. Keep old accounts open
It may be tempting to close accounts you no longer use, and at one time that was the common advice. But with today’s Utilization Ratio calculations, it is better to leave older accounts open.
Why? Their very low balance (even zero balance) averages in to your Utilization Ratio. As soon as you close the account, you suddenly take away a whole big chunk of available credit and you look like you are more maxed out across your other accounts. To keep these old accounts open and active, you may have to use them once in a while to keep them open. Just call the lender and find out how to keep the account active. If the account stays inactive for long enough, the lender will close it themselves, giving your Utilization Ratio a hit anyway.
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Two bonus Credit Ninja tactics
Bonus Ninja Tip 1: Apply for a new credit card (after your credit is restored)
One way to instantly increase your available credit (and improve your Utilization Ratio) is to apply for a new credit card. The first month after applying, you may take a small hit to your credit score – any time you apply for new credit, your loose a few points. But, you will recover those points, and more, the following month when your Utilization Ratio recalculates.
For this you work, you have to follow two important rules… 1) Keep all your other accounts in good standing and 2) Don’t go crazy with your new account. Use it for things you would have to buy anyway (like gas and groceries) and PAY IT OFF right away. Bottom line – keep that new balance LOW! (Remember… under 10 percent.)
Bonus Ninja Tip 2: Become an authorized user
If you are lucky enough to have a family member that has excellent credit AND trusts you enough to allow you to become an authorized user on one of their accounts, you can do even more for your Utilization Ratio.
There’s a lot that goes into being a responsible authorized user (read more here), but the basics are simple. The key is to become an authorized user for an account that has a long history, a high limit, and a very low balance. You get a double credit boost – your Utilization Ratio gets recalculated AND you get to “borrow” the card’s long history. This is one of the quickest ways to increase your credit score, but it is a tricky one. So learn all the facts before you try it.
If you have any questions, please give us a call at 770-952-5168 or contact us online.
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5 Credit Facts You Have To Know
Keeping the Wolves at Bay – Safely Communicating With Debt Collectors
Rising Home Prices Make Credit Restoration Critical
This information is intended for informational and educational purposes only and not as legal advice. If you have concerns about your credit report, harassment, identity theft, illegal collections activity, garnishments, or property liens, you should consult an attorney who specializes in consumer rights and defense.