Credit utilization is one of the most important factors when calculating your credit score. This is because the higher your credit utilization is, the lower your credit score will be. Thankfully, lowering your credit utilization is easy and has an immediate effect on your credit score.
Also, unlike the other factors that affect your credit score, credit utilization is a powerful tool that you can easily tweak if you want to improve your credit score in a short amount of time.
Usually, it would take you years to recover from a missed payment or bankruptcy. And as we all know, these two can affect your credit score immensely. However, if you are looking to get a loan for something but are in doubt because of your poor credit score, you can boost it within a few months by improving your credit utilization.
Before we talk about how to reduce your credit utilization ratio, let’s first talk about what credit utilization means.
What is credit utilization?
In simpler terms, credit utilization refers to the amount of credit you used compared to all of your available credit. Usually, it’s presented with a ratio that lenders check as a factor of your application for a loan.
Your credit utilization ratio is calculated with your overall available credits from all of your accounts like credit cards, mortgages, student loans, and the like.
For example, Claire has 7k dollars worth of debt and Hank has 9k dollars of debt. In this case, you might think that Claire has lower credit utilization because she has a smaller debt.
However, let’s say that Claire has 15k dollars worth of available credit while Hank has 22k dollars overall. This would make Claire’s credit score be much lower than Hank’s since she utilized more of her available credit.
So why is this important? This is because even if you have a big debt, your credit score will still be improved if you didn’t utilize your overall credit.
As mentioned earlier, the lower your credit utilization is, the better your credit score will be and vice versa. So how would you reduce your credit utilization? Here are some tips for doing just that.
Ask for Higher Credit Limits
If you’re struggling to keep your credit utilization, you can ask your lenders to give you some room by asking for a higher credit limit. Nowadays, because of the COVID-19 pandemic, they are more lax with their policies, so asking for a higher borrowing limit is a good option, especially if you’re in good standing with them.
If you’re worried about getting approved, you can ask a friend or a relative to add you to an established account. You won’t need to ask for a card or even tell you the account number for your credit score to benefit. However, you must be careful about this because being in a person’s account with a poor credit score will affect your credit score as well.
Pay Your Balances Early
If you’re planning to pay your balances to reduce your credit utilization, that’s good as well. However, there are times that your lender will issue a report to credit bureaus before you pay your balances, which can negatively affect your credit score. That said, you can ask your lender so you can be certain about it.
Open a New Account
If you’re looking to increase your credit utilization, you can open a new account instead. This will increase your overall credit and, in turn, reduce your credit utilization. Not only that, if you are qualified for a balance transfer account, find one with 0% APR.
This way, you can transfer all of your balances and pay them without any interest. Generally, the 0% APR is only temporary, which means you have to pay your balances as quickly as you can.
However, there are a few cons when opening up a new account. One is that your average credit account age will be reduced, which is another factor in calculating your credit score.
Also, you might be tempted to use the account for spending, which is not the point of opening a new account in the first place.
Don’t Close Unused Accounts
In an attempt to be more organized with their accounts, a lot of people close unused accounts to remove financial clutter. This is a huge mistake. Sure, it will make your financial management easier, but it will also reduce your overall available credit.
Also, it might impact the average age of your account, further reducing it. It’s a double-whammy at this point.
Managing your credit utilization is a simple way of improving your credit score. You have to focus on your available credit and balances while keeping the latter as low as possible.
Also, credit utilization is a good way to improve your credit score if you’re still recovering from bankruptcy or missed payments. It might have a few caveats, but it’s quick and easy to do.