credit utilization and why it matters
Finance

What is Credit Utilization and Why It Matters

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credit utilization

Credit utilization comes down to how much of your credit limit you are using. The higher your credit balance is to your credit limit, the lower your credit score. Lower credit utilization means higher credit scores. So when it comes to improving your credit score, it’s pretty important.

Why does credit utilization matter?

Did you know that amounts owed on accounts contribute 30% towards your credit score, right behind payment history? That means that your high balances are hurting your credit score. And a lower credit score typically means higher interest rates and other fees. When it comes to your credit balances, credit bureaus compile the information onto your credit report where other lenders, credit card companies, and even employers can see. Yikes!

Related Article: How to calculate your credit score and how to improve it

What is considered a good credit utilization ratio?

Most credit gurus agree that 30% is a good rule of thumb to abide by. Let’s do the math together. For example, with a $1,000 credit limit, the recommended balance would be at or under $300. Some financial experts, however, seem that the perfect utilization ratio is up for debate. That being said, it’s a good idea to avoid maxing out your credit limit.

credit utilization

How do I improve my credit utilization?

The best strategy to improve your credit utilization is to pay down your balances. By keeping your balances low, you’ll be able to effectively reduce your spending and also improve your credit score. Whoopee! Although it’s easier said than done, cutting expenses will drastically give you the financial wellbeing.

Related Article: Credit Reports Demystified

What is debt-to-income ratio?

Back when I was a loan processor, this was an important topic that many people did not know enough about. Debt-to-income ratio is related to credit utilization, but different because it factors income amounts versus debt. In simple terms, the debt-to-income ratio is best when your income exceeds your debt. For example, if you earned $10,000 a month (wish I did!) but spent $11,000 a month, your debt-to-income (DTI for short) would be high.

Why is DTI important?

Guess what, even some high-income earners with lavish tastes don’t qualify for the best credit or loan terms! The good news is that by conscious spending habits, the average Joe or Jane can qualify for reasonably good credit or loan term, so you don’t have to worry about having the most money in your bank. DTI is important because it helps you prioritize your spending, especially right before you apply to a mortgage or another installment loan.

Conclusion

Have you ever thought about paying off debt, but didn’t know how? I definitely was one of those people. I was caught up in trying to impress people with my outfits and nice makeup that I forgot about myself! I soon realized I was over my head and thankfully had some great family and friends to lead me to some answers. I soon paid off debt and eventually started my track towards financial independence. I’ve now paid off over $72k in loans not including credit card debt!

Where are you on the debt free journey? Comment below, I want to know!

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