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What is a “credit utilization ratio?” It’s a measurement of how much of your available credit you’ve already used. If you’ve used none of that available credit, then your ratio would be sitting at 0%. If you’ve used up all of that credit and maxed out your accounts, that ratio would be at 100%. You don’t want your rate to hit either of these extreme ends of the spectrum.
So, what credit utilization ratio should you strive for?
The Ideal Ratio
The ideal credit utilization ratio that you should strive for is 30%. This utilization ratio is better than 0% because it is much more realistic. A 0% ratio would be extremely difficult to maintain in the long term. To achieve such a low score for a lengthy period, you would have to stop using credit accounts altogether, which completely defeats the purpose of having credit.
A 30% ratio allows you to use a significant amount of the credit that you have available without pushing that usage past the halfway point. This is a percentage you can maintain in the long term.
Why Should You Keep Your Credit Utilization Ratio Low?
Safety Net for Emergencies
Credit is an excellent tool for handling emergency expenses when you don’t have enough savings readily available. If your credit utilization ratio is high, you might not have much available credit to use in emergencies.
Say that you own only one credit card, and your outstanding balance for that card is incredibly close to the set limit. If you’re hit with a surprise expense, you might not be able to use the card without maxing it out.
The same rule applies to other types of credit tools, like lines of credit. If you need to cover an emergency expense, and you don’t want to use a credit card, you could try to apply for a line of credit online as a backup plan. As long as you meet all of the requirements, you can submit that application and wait to learn about your approval status. With an approved line of credit, you could request a withdrawal that would help you pay for the emergency expense and then replenish the line of credit’s balance afterward.
But, if you don’t replenish your line of credit’s balance, you can’t rely on it again in the future! You might not have enough available credit to borrow from. So, if you want your credit accounts to be dependable safety nets, you’re going to have to keep your credit utilization low (ideally, at 30%).
Credit Scores
Your credit score shows lenders how responsible you’ve been in the past with your credit accounts, which will help them estimate whether it’s risky for you to take on a new account, whether it’s a credit card, personal line of credit, mortgage loan, auto loan or business loan. A high credit score means you’re a low-risk borrower, which increases your likelihood of getting approved for these types of credit accounts.
One thing that will impact your credit score is your credit utilization ratio. A high ratio is more likely to damage
your score and make it lower than you’d like. A low ratio should have the opposite effect on your score.
Other factors that affect your credit score: your credit history, your payment history, your credit mix (the types of credit accounts that you have) and your new credit.
Easier Repayments
Finally, one of the simplest reasons to keep your credit utilization ratio low is that it will make repaying what you borrowed much easier. Essentially, the more that you borrow now, the more that you will have to repay later on. You will accumulate more interest over time, and you will increase your risk of paying bills late or defaulting on payments altogether.
Keeping your ratio low means your payments will be consistently small and manageable.
This is not the time to strive for 100%! You should strive for a much lower goal and try to hit a credit utilization ratio of 30%.