The average person probably doesn’t know much about their credit utilization ratio. However, it is one of the most important factors in building and maintaining good credit. Paying off debt in a timely manner is absolutely essential to keeping your credit on track. And, maintaining credit accounts over the long haul is likewise instrumental to your credit history and score. However, how much credit you utilize is just as important as paying your bills on time and having an established credit history.
The first two factors tell creditors about your level of integrity in regard to debt management. However, your credit utilization ratio indicates how well you actually manage your debt. It shows creditors if you are staying within safe debt limits. It also indicates if you are biting off more than you can chew. This single factor has the ability to impact your credit history from month to month. Whereas the other two elements tend to have a fairly static impact on your credit.
What is a Credit Utilization Ratio?
Your credit utilization ratio tells lenders the percentage of credit that you use that is available to you. For instance, let’s say that you have a total of $25,000 available in revolving credit but you only use $500 in a given month. In this example, your credit utilization ratio is 2%. This ultimately means that you are only utilizing 2% of the available credit to you for the month.
This ratio can fluctuate from month to month depending on how much credit you utilize prior to the closing date on your revolving accounts. If you max out all of your revolving debt accounts but pay them off prior to the closing date, then your credit utilization ratio will be 0%. Lenders only report the outstanding debt on revolving accounts each month after the billing statement closes. So, determining your credit utilization ratio can be a bit tricky if you pay off debt at different times of the statement cycle.
The average person tends to pay revolving debt over time. This means that they will typically have a credit utilization ratio above 0%. And, that may be okay depending on certain factors. It’s never a good idea to have a high credit utilization ratio, however, carrying a 0% credit utilization ratio is not always good either.
What is the Best Credit Utilization Ratio?
Determining the best credit utilization ratio is dependent on a few factors. The first criteria is ensuring that you stay below the credit industry standard of 30%. Many credit experts agree that a 30% or higher ratio is risky and this rate definitely has the potential to lower your credit score. This may not mean much if you maintain a good to excellent credit score. However, it could significantly lower your credit score if it is poor to average.
While you don’t want to go above 30% of your overall credit utilization, you also don’t want to stay at the upper limits of this number for prolonged periods of time. Maintaining a 10%-20% credit utilization ratio is better but it is still not ideal if you are trying to increase your credit score. If you have poor to average credit, I recommend maintaining a credit utilization ratio of 5% or lower. This keeps you within safe limits for yourself and it is more attractive to potential lenders.
Keep in mind that this ratio has the ability to influence your credit on a month-to-month basis. So, you do have the opportunity to redeem yourself from month to month if you need to carry a higher than normal balance at times. But, on average stay at the lower end of the credit utilization spectrum.
Why 0% credit Utilization is not always good
If you are trying to build credit you need to show that you use credit responsibly. In order to do so, you should wait for your statements to close before paying off your balances. As I mentioned earlier, credit utilization is reported after the billing cycle closes. If you use revolving debt and pay it off prior to the closing date of your billing cycle, you will have a 0% credit utilization score.
This prevents you from building a solid credit history. Therefore, you should maintain a small credit utilization ratio on a regular basis. This ratio can be anywhere from 1%-10% depending on your credit-building goals. You can and should pay your balances in full after your billing cycle closes though. Carrying a balance on revolving debt is rarely advisable.
The general rule of thumb is to keep your credit utilization ratio as low as possible. This is especially important if you have little to no revolving credit available to you. For instance, if you have $50,000 worth of revolving debt available, try to maintain a 1%-5% credit utilization ratio. The more credit you have available to you, the more you can increase your credit utilization ratio without it impacting your credit too much. But, stay below the 30% mark regardless of how much credit you have available to you.