Credit Scores Are Effected by Your Credit Card Spending Habits
There is a lot of confusion around how credit scores are effected by one’s credit card use. In fact, most of us don’t think about any particular strategy or method to buying things using credit cards except not to go over the limit and to make our payments on time. Have you heard of revolving debt ratio, or credit utilization ratio? In today’s post, an often misunderstood concept of revolving credit utilization ratio will be clearly explained so that your credit profile from month to month is looked more favorably upon by FICO, and thus, optimize your score.
First, revolving credit is a unique type where you are given what is also called a line of credit. This means you are given a certain maximum amount of credit that can be used anytime and is replenished each time you pay it back, making it available again for use. (Dictionary.com definition here). The most common example of this type is credit cards.
Revolving Debt Ratio
Revolving debt ratio as applied to credit cards is simply the ratio of the amount which has been used (charged) on a particular credit card at the time of calculation to that card’s maximum available credit. For example: If you have a card with a $5000 credit limit and you have used $1000 on purchases, then your utilization ratio for that card at that current time is 20% ( $1000/$5000 = .20 , or 20%). This would apply to business lines of credit and home equity lines of credit the same way. Tweet This Example
Why is this important, you might ask? FICO has said on their website that revolving debt ratio is one of the factors it considers in calculating your score, and can account for up to 30% of your FICO score calculation. The the lower the ratio, the better one’s score is, and the opposite is true, of course, the higher the ratio, the lower one’s score. The common phrase “maxed out” comes to mind. When credit cards are maxed out, that means all available credit has been used and a 100% utilization ratio has been reached. FICO “penalizes” consumers for maxing out because it shows they possibly rely on borrowing too much (or are in too much debt), and/or may not be the best credit and debt managers.
FICO does consider other aspects of credit utilization ratio on your credit profile to some degree, like how many accounts have balances, and even installment loan utilization ratio, but revolving debt ratio is by far the most important and easiest to influence when trying to optimize your credit score.
Clear as mud? Please feel free to ask us any questions you may have on this subject.
- In today’s post, an often misunderstood concept of revolving credit utilization ratio will be clearly explained. (Click to tweet)
- When credit cards are maxed out, all available credit has been used and a 100% utilization ratio has been reached. (Click to tweet)
- Revolving debt ratio is by far the most important and easiest to influence when trying to optimize your credit score. (Click to tweet)
By Blair Warner – Upgrademycredit.com Chief Editor and Sr. Credit Consultant