To get or maintain a good credit score, which can help you save thousands of dollars on auto loans, private student loans, mortgages, and even credit card interest rates, you don't have to make huge shifts in your behavior. Sometimes, even small changes can make a big difference, says Ted Rossman, industry analyst at Bankrate.
"The most impactful thing that consumers can do to quickly improve their credit score is to lower their credit utilization ratio," Rossman recently told Grow.
Your credit score gives lenders a sense of how likely you are to pay back what you owe, meaning it's a reflection of your creditworthiness. The three major credit bureaus (Experian, Equifax, and TransUnion) calculate your credit score by taking into account a number of factors, like your payment history and length.
Your credit utilization rate, which is the amount of credit you're currently using divided by the total amount of credit you have available, is the second biggest factor when calculating your credit score. It accounts for nearly a third, or 30%, of your score, based on FICO's model. If you have a high credit utilization rate, you might have a more difficult time making monthly payments and ultimately end up with a lower credit score.
Banks measure your credit utilization rate on individual cards, as well as across all of your available credit. To calculate your credit card utilization, divide the total credit you're using by your credit limit. "Ideally, your credit utilization ratio will be below 30%, and most people with the highest credit scores keep it below 10%," Rossman says.
That means if you have a $1,000 balance on a card with a $5,000 line of credit, your utilization rate on that card is 20%. If the total credit you have available across two credit cards is $10,000 and you have a total balance of $1,000, then your overall utilization rate is 10%.
Here are three ways experts recommend to keep your utilization rate low.
"The best way to keep utilization low is to not carry a balance," says Matt Schulz, chief credit analyst at LendingTree. "Your card's interest rate might be 20% or higher, but if you never carry a balance from month to month, that rate becomes a moot point because interest will never accrue."
Nearly a quarter of Americans have increased their credit usage during the pandemic, and if you're one of them, it's especially important to protect your credit score.
By reaching out to your credit card issuer, you might be able to skip a payment or two, get a lower interest rate, or waive fees to protect your credit score. And in response to the widespread need for relief, card issuers are becoming more flexible, Rossman told Grow, so you probably won't have to do too much "begging or explaining" to get a break, either.
"If you're struggling, let your lender know before you fall behind. Often, help is available and can protect your credit score, but you need to ask," he says. "If you pay less, or if you pay late, it's OK as long as you have permission. So speak up early."
Paying off debts can be a challenge even when the economy is thriving. It's much harder now for many Americans who are struggling to make ends meet.
If you can't pay off your credit card in full each month, make sure you're at least paying the minimum on time by setting up automatic payments. This can help you avoid penalties and fees.
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You may think canceling a credit card you no longer use is a good idea. However, closing an old card can actually hurt your credit utilization ratio because it means you'll have less credit available overall.
"As long as the card doesn't have an annual fee, you're likely better off holding on to a rarely used card instead of closing it," says Schulz.
"If you have a balance of $1,000 and $5,000 of available credit, your utilization is 20%, he adds. "If you close a card and reduce your overall limit to $2,000, your utilization rockets up to an unacceptably high 50%." That's significantly higher than the recommended share of 30%.
In other words, even if you're carrying the same amount of debt, canceling a card can mean you'll end up with a higher credit utilization ratio and perhaps a lower score.
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A balance transfer allows you to move an outstanding balance from an existing credit card to a new card with a low or even zero interest rate.
"Transferring a balance can save you a ton of interest and can help your utilization rate" because you won't have compound interest working against you and adding to the balance, says Schulz. By opening a new card, you'll also add to your overall credit limit.
"It might be harder to get that balance transfer credit card today, during the pandemic, than it was a couple of months ago," he says. "However, it is still worth trying."
These low APR offers generally last for a year or two, so you'll want to pay off your balance before the introductory offer expires and high interest rates kick in. And watch out for transfer fees: "An increasing number of these cards are charging 5% upfront to transfer balances, while others charge 3 or 4%," Rossman warns.
Given that there are few balance transfer offers right now, you're better off applying for a new card and going through the back door with an existing card relationship, says Rossman. "It definitely doesn't hurt to ask."
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