Credit cards have become an essential tool for purchase transactions and managing finances. While credit cards have several benefits, it's best to use them with care because poor credit management can negatively affect your credit score. Your credit score calculation is based on multiple factors, one being your credit utilization ratio. Here's what that is, why it matters and how to manage it.
What is a Credit Utilization Ratio?
Your credit utilization ratio is the percentage you use of your entire credit limit, specifically on a loan or credit card. For example, if you have two credit cards with limits of $2,500 your total limit is $5,000. If you have a total balance of $3,000 between both your credit utilization ratio is 60%.
Lenders will use this ratio to determine how much credit risk you pose as a borrower. For example, a higher percentage will indicate to lenders that you are using too much of your available credit. This could suggest that you're overextended or unable to manage your finances properly.
Impacting Your Credit Score
Your credit score is based on several factors, including your payment history, credit history length and the types of credit you use. However, your credit utilization ratio is one of the most significant factors affecting your credit score. Lenders view a high credit utilization ratio as a sign of financial instability. Therefore, a high ratio can negatively impact your score.
Low credit scores make it more challenging to qualify for loans and other credit cards in the future. The loans you can get may have unfavorable terms like higher interest rates or lower credit limits. Therefore, building and maintaining good credit is essential for financial security.
Managing Your Credit Card
Managing your credit card is crucial to maintaining a low credit utilization ratio. One of the best ways to do this is by paying your balance in full each month. Paying off your balances will ensure a lower ratio while avoiding paying interest charges. If you cannot pay your balances in full each month it's best to keep your overall balance as low as possible.
Another way to manage your credit card utilization ratio is by requesting a credit limit increase. The best way to ensure an increase in your credit limit is by having a good score and a low balance. Increasing your total available credit will also lower your credit utilization ratio.
Takeaway
By responsibly managing your credit card usage, you can maintain a good credit score, avoid debt and make informed financial decisions. Understanding your credit utilization ratio and how to manage it can help you achieve your financial goals and build a strong foundation for your financial future.
Want to Learn More?
Stop by our Financial Training Ground and check out all the great resources that can help you strengthen your financial future. From using loans and credit to planning retirement, there's something for everyone! Click the link to explore today.