Whether you're applying for a mortgage, an auto loan, or a credit card, having good credit can open the door to a world of borrowing possibilities. That's why it's important to keep your credit score as high as possible.
One major factor in your credit score is something known as your "credit utilization ratio." Your credit utilization ratio represents the percentage of available credit that you're actually using. A credit utilization ratio of 30% or lower is considered good, while a ratio that exceeds 30% could bring down your credit score. Thankfully, there are things you can do to keep your credit utilization ratio in favorable territory and preserve your credit score in the process.
What goes into a credit score?
There are five key factors that go into determining a credit score, as follows:
- Payment history (35%), which speaks to your bill-paying habits (namely, whether you make payments on time)
- Credit utilization ratio (30%), or the amount of available credit you're using
- Length of credit history (15%), or the amount of time your oldest account has been open
- New credit accounts (10%), meaning the number of accounts you've recently opened
- Credit mix (10%), which represents the variety of credit accounts you have
Aside from your payment history, your credit utilization ratio carries the most weight in calculating your overall score. Keeping that number down is therefore essential to building and maintaining good credit.
How much of your credit are you using?
You might assume that the more debt you have, the lower your credit score will be. But in reality, the amount of debt you have isn't actually as important as the extent to which you're using your available credit.
Say you have a $10,000 line of credit and $4,000 in outstanding debt. Your credit utilization ratio will be 40%. Your pal down the street might have $8,000 in outstanding debt -- twice as much as you -- but if his total line of credit is $30,000, then his credit utilization ratio is just under 27%, which is considerably better than yours. It's always a good idea to keep your total debt as low as possible, but for the purposes of keeping your FICO credit score high, you should focus on your credit utilization, not your total debt owed.
Lowering your credit utilization ratio
Bringing down your credit utilization ratio is one of the quickest ways to boost your credit score. The most efficient way to lower that ratio is to simply pay off a chunk of your existing debt. If that's not feasible, however, then you have a few other options. First, you can try contacting your lenders and asking for an increase in your credit limit. If your accounts are in good standing (meaning you're making your minimum payments on time), there's a good chance your lenders will comply.
If that doesn't work, then another option is to try opening a new credit card with a generous limit. This might knock your score down initially (because you'll have a hard inquiry on your record), but it will increase your available credit and thus lower your credit utilization ratio -- which carries far more weight than your new credit accounts.
Finally, you can also try getting added as an authorized user on somebody else's credit card. Even if you don't actually use the card, that person's credit limit will be tacked onto yours, which can help bring your credit utilization ratio down.
The better your credit, the more options you'll have for buying or renting a home, purchasing a vehicle, or getting approved for another type of financing. If you make a point to keep your credit utilization ratio at or below 30%, you'll be doing your part to build or maintain a respectable credit score that will ultimately serve you well.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at firstname.lastname@example.org. Thanks -- and Fool on!
The Motley Fool has a disclosure policy.