If you have credit cards in your wallet, you can track your balances to control your budget, but …
If you have credit cards in your wallet, you can track your balances to control your budget, but knowing each card’s credit limit is another story. However, actively managing how much of your credit limits you use, also known as the credit utilization ratio, can have a big impact on your credit score.
Your credit score is a mix of many factors, including your use of credit. If you want to build your credit score, focusing on using under your credit limits is a powerful way to do it. People with excellent credit tend to have low credit utilization rates.
According to credit expert John Ulzheimer, use is one of the most tangible ways to improve your credit: “To the extent that you have the capacity to pay off your credit card debt, your ratios will go down. It’s just a fact.
Even if you can’t reduce your balances, there are a few other strategies that can help reduce your credit usage.
WHAT IS A CREDIT LIMIT AND WHO DETERMINES IT?
Your credit limit is the maximum amount you have been allowed to spend by a creditor, based on factors such as your payment history, income, and credit rating. A credit limit is not set in stone and is subject to change during the life of the account: your card issuer can increase or decrease your limit without warning, and you can also request a credit limit increase (we will come back to this later).
HOW YOU USE YOUR CREDIT LIMITS CAN HELP YOUR SCORE
Make sure you know your credit limits. Try checking your last bill or your last banking app to find out the limit for each card. With your limits in mind, you can focus on keeping your balances low.
Ideally, you don’t want to use more than 30% of the credit limit on any card. The lower this credit utilization rate, the less risky you seem as a potential borrower. People with the highest scores tend to use less than 10% of their limits. You can calculate your credit usage rate by dividing your balance by your credit limit. Multiply this number by 100 to get a percentage.
Keeping tabs on your credit usage is as easy as setting an alert once you’ve hit a certain spending threshold. Most cards will allow you to do this. Many personal finance websites and apps also have a dashboard that shows your usage.
There are other strategies that can help you reduce your use of credit. “Pay an amount before you get your statement,” says Chi Chi Wu, an attorney at the National Consumer Law Center. “
Ulzheimer suggests two other ways to reduce your consumption: Start by trying to reduce your credit card balances if you have month-to-month debt. Or you can ask to increase your credit limit, which not only gives you more flexibility to make larger purchases, but also helps lower your credit utilization rate.
“If you can do both at the same time – lower balances and higher credit limits – then again, you’ve lowered your ratio,” says Ulzheimer.
This only works if you can keep your balance low and resist any temptation to increase your spending. Also note that asking for a higher limit may temporarily affect your credit score.
THE COVID CONNECTION
For a real-life example of how credit usage and credit score are linked, look no further than the COVID-19 pandemic. Recent data from credit rating firm FICO shows that in 2020, many Americans took advantage of spending cuts and government stimulus checks to pay down consumer debt. According to FICO, average credit card balances decreased by 10.9% and the average FICO score increased by 8 points between April 2020 and April 2021.
Doing something simple, like using extra money to pay off existing credit card balances or making multiple payments throughout the billing cycle, can improve your credit, even in tough financial times.
This article was provided to The Associated Press by the NerdWallet personal finance website. Amanda Barroso is a writer at NerdWallet. Email: [email protected]
NerdWallet: Tips for reducing credit usage https://bit.ly/nerdwallet-credit-utilization
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