Most Americans aren’t clear about how their credit card balances affect credit scores, according to a new survey by U.S. News.
Of those who indicate that they understand there is a relationship between the two, almost four in 10 people say a high credit card balance increases their credit score, which is incorrect.
How Your Credit Utilization Ratio Impacts Your Credit Score
Your credit utilization ratio is the amount of credit you’ve used compared with the amount of credit you have available. This is important to know because your credit utilization makes up 30% of your FICO score. To avoid harming your credit score, your ratio should be below 30%. But consumers with high credit scores tend to have ratios of less than 10%.
While the early December survey shows that a majority don’t understand how utilization ratios affect their scores – about 24% say a higher ratio is better, and nearly 36% say they don’t know – there is some good news to report. A little more than 40% of respondents select the correct answer: The lower your ratio, the higher your score.
Asked what their credit utilization ratio is on their credit cards, almost 8% don’t know. But overall, most respondents are aware of their ratios and report the following:
- Slightly more than 37% keep a ratio of 10% or less.
- Almost 80% keep their ratio to no more than 30%.
- Around 13% have ratios between 31% and 50%.
- 7% have ratios that exceed 50%.
Another important fact to know about ratios: The FICO algorithm considers your ratio on each credit card as well as your ratio across all of your credit cards. A high balance on just one credit card can still decrease your score. So, if you have one card with a ratio more than 30%, focus on lowering the balance on that card.
Beware High-Limit Credit Cards While Holiday Shopping
With the holidays here, consumers are likely to purchase more with their credit cards. And since some purchases will be expensive, such as a new laptop, it makes sense to use a high-limit credit card.
Generally, high-limit credit cards have a credit limit of at least $5,000. In the survey, more than 59% of respondents indicate that their limit is between $10,000 and $24,999. And nearly 12% have a credit limit of $25,000 or more.
With high credit limits, it can be difficult to remember that you still need to keep your cash flow in mind. It’s important to have a holiday budget so you don’t spend more than you can pay off when the balance is due. Unfortunately, many Americans are carrying debt from month to month.
Majority Carry a Credit Card Balance
Nearly 39% say they always pay their balance in full every month, which is what I recommend doing when using credit cards. But the survey results also show that many respondents carry a balance on their credit cards.
Here are the findings among those who have carried a balance:
- About 36% say they rarely carry a balance.
- 23% carry a balance for two to three months.
- More than 17% carry a balance for four to six months.
- More than 23% carry a balance for more than six months.
It’s common for high-interest credit cards to offer rewards, which means there might be an annual fee. Rewards cards also tend to have higher annual percentage rates. If you carry a balance, you’ll pay compound interest on your purchases. This has the potential to offset any rewards you earn, especially if you’re also paying an annual fee.
Your mantra should be: I’ll always pay my credit card balance in full by the due date. Say this over and over until it’s a habit. That way, you earn rewards and you stay out of debt.
4 Ways to Lower Your Credit Utilization Ratio
If you’re carrying a balance on your credit cards, vow to pay off your debt in the new year. But there are some steps you can take right now to improve your credit utilization and boost your credit score.
- Increase your credit limit. A slight majority – 51% of respondents – have never asked for a limit increase. But of those who have requested one, almost 92% were successful. Obviously, don’t do this if your payment history is unstable or if you’ve maxed out a credit card, because your request will likely be denied.
- Make two monthly payments instead of one. If you can swing it, making two payments during the month can lower your utilization ratio. Call your credit card company and ask when it reports your payment history to the credit bureaus. This way, you can make double payments before it reports your information to the bureaus, which will lower your ratio.
- Apply for a new credit card. This move increases your available credit. Take your time and compare credit cards so you choose the right type of rewards for your spending style. While this strategy improves your ratio, you also want to get a credit card that helps you earn the most rewards. And don’t use a new card as an excuse to spend more.
- Don’t close credit card accounts. Remember that your ratio is the amount of credit you’ve used divided by your available credit. When you close a credit card, you lose that available credit, which increases your ratio. So, don’t close an account unless there’s a costly reason, such as a high annual fee that you can’t afford.