what’s your credit score?
If you know this three-digit number, do you know why it is the way it is?
While your score is a complex number that’s constantly changing, it is the product of many factors involved with your borrowing behaviour. One of them is your utilization ratio. Never heard of it? Keep scrolling to learn why your credit utilization ratio matters when it comes to your line of credit or credit card.
What is a Utilization Ratio?
This mouthful of a financial term is a relatively simple concept. It shows how much of your available credit you use at any given time.
Many of the major credit scoring models consider your ratio when tabulating your score. It’s part of several factors impacting your history.
Whether you use 10 percent or 100 percent of your limit gives insights into how you manage your money. Specifically, it lets financial institutions know the following two things:
- How often you tap into a line to cover expenses
- How often you carry over a balance month-to-month
A High Ratio isn’t a Good Thing
When it comes to your financial health, your utilization ratio isn’t a high score you want.
It means you’re carrying over a balance often, which may suggest your budget is off-kilter. It might even mean you’re struggling to pay bills or charging items you can’t afford.
A Low Ratio is What You Want
In terms of this metric, a low score reflects well on your financial habits. To keep yours low, you can’t tap into your line often, and when you do, you must pay off your balance in full. This suggests you have the money for every purchase your charge to the account.
What is a Good Utilization Ratio?
If lower is better, just how low do you have to go?
Technically, zero looks great to those financial institutions that care about ratios. A ratio of zero is impossible unless you pay off the balance in full, no matter what.
That being said, it’s a challenging objective — even if you rarely carry over a balance.
It has to do with the timing of your financial records. If you generate a credit check between using your card and making a payment, your file may show you have a balance.
That’s why it’s so important you don’t max out your cards even when you can afford to pay it all back. A common rule of thumb recommends using 30 percent or less of your limit at any given time.
How Do You Lower Your Ratio?
Improving your ratio relies on many of the same good money management tips that apply to your finances across the board. These tips include:
- Using a budget to make sure you can afford bills and other expenses without help
- Paying your bills on time, every time
- Paying your bills in full, relying on the minimum payment only in emergencies
- Using your line on unexpected emergencies only and not daily expenses
The next time you pick up a line of credit or credit card, think about how your next purchase may impact your finances. Will you be able to follow the tips above after you make it? If not, reconsider whether you need to buy that item, service, or experience. Putting it off until you can afford it is a great idea!