Credit Utilization Ratios Explained – Episode #103
Credit Utilization Ratios Explained
One of the most important factors that makes up your credit score is your credit utilization. What is credit utilization ratio? It’s the ratio of your credit used to the credit available to you. Both, the aggregate ratio – the total credit used/total credit available – and the individual credit utilization ratio – will impact someone’s credit score.
Here’s an example. Someone with a $10,000 limit total across 4 cards, who then uses $2,000 of her credit has a credit utilization ratio of 20%. But, that’s not the only measure. Let’s say we have two people with this situation Jack and Jim. If Jack is spreading his $2,000 used equally across all 4 cards, and his credit limits are equal across these cards, then he has an aggregate ratio of 20% but also individual ratios of 20% on each card. If Jim has $2000 on one card, he has a 20% aggregate ratio, but 100% utilization on 1 card and 0% on the other cards. As the credit score system doesn’t like to see maxed out cards, Jim’s 100% ratio hurts him more than his 0% usage helps and therefore, his score will be lower than Jack’s credit score.
This example points out the importance of managing both your aggregate and individual credit utilization ratios. Normally, when I’m coaching someone out of debt, I have them pay off the highest interest rate card first. That’s going to save them the most money, but it might not lead to the highest score increase in the near term. If it’s a higher credit score you are after, it might make sense to pay down maxed out cards first regardless of the interest rate on the cards. This will help you get a higher score, which you may need for a new car or home loan, and that will save you more over the long run than the savings on your credit card.
Comments
Ask a question, make a comment, share tips