Word of the day: Credit utilization ratio
Creditors use a calculation called a credit utilization ratio, which makes up 30% of your FICO score
. Next to your payment history (which makes up 35%), it has the second-largest impact on your credit score. A credit utilization ratio measures how much credit you’re using compared to how much you have available.Your credit score decreases as your balance increases in relation to your total available credit. The more unused credit you have, the better your score because it shows creditors that you’re responsible. This makes you a better credit risk. It’s best to utilize no more than 10% to 30% of your available credit.
Lowering your balances will help raise your credit score. Start by consistently paying more than the minimum on your accounts, which will lower your utilization. You can calculate your ratio by dividing your credit card balance by your credit limit. Then, multiply by 100. The result is your credit utilization as a percentage. For example, if your credit card limit is $1,000 and your balance is $500, then your credit utilization is 50% (500/1000 = .5 (x 100) = 50%). It’s best to have a low credit utilization ratio; the lower the better.
Note that closing unused credit cards can hurt your score because you’re lowering your available credit, which in turn increases your ratio.