One quick way to improve credit scores is by using less of your available credit. The amount owed on accounts contributes 30% to a FICO Score's calculation and can be easier to clean up than payment history.
The FICO credit scoring system rewards consumers that utilize less of their entire available credit limit. High outstanding debt will negatively impact your credit score.
When credit limits are close to “maxing out” that high credit utilization signals to the FICO scoring system you may have trouble making payments in the future. Your FICO score will take a hit when high credit card balances are indicated.
According to myfico.com, on average, “exceptional” credit score holders use about 7% of their available credit.
Keep balances low on revolving credit
Credit cards are a perfect example of revolving credit. Lines of credit are also considered revolving credit. With revolving credit, a bank allows you to continuously borrow money up to a certain credit limit.
Every time you buy something on credit, that amount is subtracted from your total credit limit. And every time you pay off your balance, your credit limit goes back up. Revolving credit is also considered open-end credit because the length of the loan isn't fixed — it's ongoing.
Figuring out your credit utilization
The lower your credit utilization ratio the better your FICO score. Here is an example of credit utilization:
- Let’s say you have a $10,000 limit credit card and have a balance of $3,000 on that card — your credit utilization would be 30% of your available credit.
- But if you owed $9,000 a credit card with a $10,000 limit — your credit utilization would be 90% of your available credit.
For every card that has a balance (meaning you got a bill this month), divide that balance by the credit limit. Then multiply that figure by 100 and you’ll get the utilization percentage on that card.
The balance on your statement is what gets reported to the credit bureaus. As long as the balance is showing up on your credit report then you will have a utilization percentage greater than 0. Even if you pay in full each month the balance reported to the credit bureaus may not be 0. In order for your balance to report 0 you must pay in full before the statement cuts.
High overall credit utilization is the problem
The method for calculating overall credit card utilization is exactly the same as calculating individual credit card utilization, except for one difference. Just add together all of the balances on your credit cards and all of the credit limits as well. Then you’ll divide the aggregate balance by the aggregate limit. Getting your overall credit utilization down is most important.
Even if you have a credit card without a balance, it still needs to be included in the aggregate credit limit amount, which will help your percentage. The unused limit helps your utilization percentage. This is the top reason you should never close credit card accounts even if you no longer use the card.
FICO states that “Closing unused credit accounts that have zero balances and are in good standing will not raise your FICO Scores.”
Maintain a delicate balance
According to FICO, consumers who have the highest scores (760 and above) have an aggregate credit card utilization of 7%.
It's interesting that it is not zero percent. FICO states that “In some cases, having a very small balance without missing a payment shows that you have managed credit responsibly, and may be slightly better than carrying no balance at all.” Having a low credit utilization ratio can be better than having a high one, or none at all.
Credit accounts that are not maxed out translate into good credit management. The credit scoring formula rewards consumers who manage credit well. The higher your credit utilization, even if you are making on-time payments, the higher risk you become. High credit utilization is interpreted as a sign of financial trouble and possible default on other credit obligations as well.
Watch out for balance transfers
Balance transfers can have an unintentional effect of increasing the credit utilization ratio which can lower your FICO scores. Should you transfer an account balance because a new credit card offers a lower rate but the new card has a lower credit limit, that would possibly put you near maxing out the new card depending on your balance.
Just be mindful of the credit limit of a new card if you are looking to do a balance transfer. If you are in this position but still want to go forward with a balance transfer you can regain credit score points by paying down the balance on the new card quickly.
Increase credit limits
Paying down your credit account balances will decrease the credit utilization ratio and thereby raise your credit score. However, it is not always financially feasible to pay down credit accounts. In this case, requesting a credit line increase can accomplish the same. A credit limit increase can raise your credit score if handled correctly. The strategy is to request an increase in credit limit but do not use the new available credit.
Credit utilization is an incredibly important factor in your FICO credit scores and is one of the easiest ways to raise credit scores quickly.