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Video: What is your credit utilization ratio?

Summary

Your credit utilization is how much credit is available to you versus how much of it you actually use.

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Have you ever looked at your car’s odometer? Most of them go up to 120 mph. Your car has the ability to go pretty fast, but unless you’re a NASCAR driver or looking to get a ticket, you don’t want to hit that speed.

Credit utilization works the same way. In a nutshell, your credit utilization is how much credit is available to you versus how much of it you actually use.

This ratio – your debt to available credit – makes up 30 percent of your FICO score, which is the credit rating that determines whether you can buy a house, get a car loan, or even rent an apartment. The higher your credit utilization ratio, the lower your score. Lenders want to make sure you can pay your debt. When you have too much debt to begin with, they may not want to take that risk.

Credit utilization can be complicated, but here are three simple rules of thumb:

  • Think twice about closing old credit card accounts. Even if you’ve paid off a credit card, you may want to keep the account open since closing it cancels the line of credit that comes with that card. So even if you’re already using a small amount of credit, when your total available credit shrinks by closing a credit card account, your utilization grows.
  • If you want to lower your credit utilization ratio, call your card issuer and ask for a credit limit increase. If you’re a good customer, your issuer may grant your request. Just make sure you don’t actually use that additional credit. That would defeat the purpose.
  • Pay down your balances. Not only does paying in full and on time lower your credit utilization ratio, it also shows lenders you’re a responsible borrower. And payment history makes up 35 percent of your FICO score.

Like your car, just because you can charge, doesn’t mean you should. Keep your credit limit high and your debt low, and you’ll be on your way to a higher credit score.

See related:How to ask for a credit limit increase

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