Boost Your Credit Score by Improving Your Credit Utilization
Credit utilization is arguably the most impactful factor of your credit score, yet it's the easiest thing you can quickly fix and improve.
If you take your outstanding credit debt as a percentage of the total credit available to you, you land on a percentage of how much credit you are currently using. This is your credit utilization rate, and lenders and creditors pay close attention to this metric to determine your risk as a borrower.
The more of your credit you use, the more debt you acquire. And if you have a significant amount of debt relative to what creditors trust you with, you will be perceived as higher risk since any additional credit they give you might not be paid back before all of your existing debt.
The good news is out of all the factors that determine your credit score, this is the fastest one to improve.
How to Improve Your Credit Utilization Rate
Here is the formula that calculates credit utilization.
credit used ÷ credit limit = utilization rate
A real example might look like this:
$7500 credit debt ÷ $30000 credit limit = 25% credit utilization rate
As you can see, improvements to our credit utilization can be approached in two ways.
- Reduce the amount of credit used
- Increase our total available credit
Ultimately we can and should attack this from both angles.
Reduce Your Credit Usage
If we use our example above, we are starting with a 25% credit utilization rate.
This isn't terrible, but to get the best credit scores we want this to fall below 10% and generally the lower the better.
The fastest way to do this is to payoff this outstanding debt so that little to none of our credit is being used.
If we transfer $5000 from our savings to cover this debt we are left with $2500 of credit debt and our credit utilization rate massively improves.
$2500 credit debt ÷ $30000 credit limit = 8.3% credit utilization rate
Getting this number below 10-15% is key to improving your credit score and paying down credit card debt will have an immediate impact that you'll see on next month's credit report.
Increase Your Total Available Credit
If we don't want to pay down our credit debt immediately, we can still improve this factor of our credit score by acquiring more available credit.
Let's go back to our example above. If we have $7500 of outstanding credit debt and we happen to double our available credit limit, we will cut out credit utilization in half without having to pay off any debt.
$7500 credit debt ÷ $60000 credit limit = 12.5% credit utilization rate
You can see we decrease our credit utilization from 25% to 12.5% just by doubling our available credit and not paying off any debt.
Please note that I'm not advocating for not paying off debt. There are times when it might not need to be your number one priority though.
Things like 0% interest credit card promotions, low-interest debt, and balance transfer promotions all can be reasons for this. And your capital can sometimes be used for a better purpose or invested for a higher return... cough opportunity cost cough...
But I'm getting away from the point.
Your goal should be to both lower how much debt you owe while increasing the amount of credit available to you.
Combining Both Approaches
Imagine if we combined both strategies now.
We first benefit from paying off debt and lowering how much credit is used. Then we increase out credit limits and open more credit cards with increases our total available credit. As a result the amount of debt we have becomes a smaller percentage of how much credit is available to us and our credit score goes up.
Here's the math.
$2500 credit debt ÷ $60000 credit limit = 4.1% credit utilization rate
If we paid our debt down to $2500 as we did in the sections above AND took action to increase our available credit to double the original amount, we improve our credit utilization by more than twice as much as either action by itself.
Paying off some of our debt while getting more available credit gets us an easy 4.1% credit utilization rate. That's definitely good enough to get you the best mortgage rates and terms.
Create a Credit Score Plan
The credit game is played in the long term.
You don't win by doing a bunch of things today and hoping for eventual improvement. You win by consistently making good credit decisions and taking advantage of knowing how the system works.
My credit plan includes:
- opening a new credit card at least once a year
- requesting increased credit limits every year
- moving all outstanding debt to accounts with the lowest interest rates
- minimizing hard credit pulls and hard inquiries
- automating credit card payments to avoid late payments
- never closing old accounts so that my credit age increases over time
As time goes on, I'll have a significant number of accounts which should result in a very high available credit limit. This will secure me with a low credit utilization rate, even if I carry a balance on some of my 0% interest credit cards sometimes.
Additionally, your total number of accounts is a separate factor of its own that affects your credit score. So that's a plus.
I hope this helps you understand the concept of credit utilization and how you can easily manipulate it to quickly improve your credit score.
I don't focus on the metric most of the time because I know when I want a new credit card or loan I can pay down debt the month before to quickly get this percentage as close to zero as I can.
Again unlike most of the other factors that go into your credit score, your utilization rate is one of the quickest metrics you can improve, so take advantage of it!