As we begin to resume more of our everyday activities following the coronavirus pandemic, we still need to protect our health. But in addition to our physical health, it’s important to protect our financial health, and one of the easiest ways is by keeping tabs on your credit utilization rate.
Defining the credit utilization rate
What is a credit utilization rate? Simply put, it’s the percentage of your total available credit that you’re using. For example, if all your credit cards combined have a total credit limit of $2,000, and your balance across those cards is $500, then your credit utilization rate – or ratio – is 25%. But how do you know if your credit utilization rate is optimal?
An ideal credit utilization rate
While there’s no magic number for the ideal credit utilization rate, financial experts generally recommend that you keep the rate no higher than 30%. Using the example of a $2,000 credit limit across all your credit cards, that means you should aim to carry a balance owed of no more than $600 in any given month. But you’re probably wondering why a lender would give you a credit limit that they don’t want you to use.
Why a credit utilization rate is important
Keeping your credit use at a modest percentage of your available limit is important to your credit score. You’ve probably heard that a good credit score is the key to receiving approvals and favorable rates when applying for a car loan, credit card, home mortgage or other financial product. A number of factors go into determining a credit score – such as income and length of employment – but your credit utilization rate is an indicator of whether you use credit responsibly and without overextending your ability to repay your debt.
How you can keep tabs on your credit utilization rate
There are a number of ways to keep track of your credit utilization rate, but the easiest way is to collect your credit card statements at the end of the month, add up the balances, and then divide the total balance by the total credit limit. Your primary bank may also offer online personal finance tools that enable you to track your accounts from outside the bank, and there are a number of free personal financial management websites and apps available as well.
What to do if your credit utilization rate starts increasing
If your credit utilization rate goes above 30% once or twice a year, it’s unlikely that your credit score will drop dramatically. But if you find the ratio regularly exceeding 30%, the first thing to do is to focus on paying down your debt, making more than the monthly minimum payment if you’re able.
One final piece of advice: Try to spread your spending across your credit cards, rather than reaching the limit on one card. It could hurt your credit score even if you have a low utilization rate on your other credit cards.
Responsible use of credit and increasing your financial awareness and understanding is important to your personal bottom line. As you focus on your physical and mental health, don’t forget to pay attention to your financial health as well.