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Is your credit utilization affecting your financial health?

The health of your credit plays a crucial role in many areas of your life. Your ability to get a mortgage, secure a car loan, or even get a job can be impacted by your credit profile.

There are several factors that influence how strong (or weak) your credit profile is, and your credit utilization ratio is one of them.

Read on to find out what a credit utilization ratio is and how it affects your credit score.

 

What is a credit utilization ratio?

Your credit utilization ratio – also known as a credit utilization rate – refers to how much of your revolving credit that you are using relative to the amount of credit that is available to you.

It’s an important factor in calculating your credit score. In fact, it holds as much as 30% of the weight in your credit score calculations. If it’s too high, your credit score could be negatively affected because that means you’re using too much of the credit you have available.

A low ratio, on the other hand, means you’re using less of your available credit, which is a good thing for your credit score. A low credit utilization ratio generally means that you’re responsible with your credit and are not overspending.

 

How to calculate your credit utilization

Your credit utilization ratio is calculated by dividing the amount of credit you’re currently using by the limit you’re allowed to spend. It’s usually represented as a percent.

For example, if your credit limit on your credit card is $5,000 and you spend $2,000 of that limit, your credit utilization ratio would be 40%. That means you’re spending 40% of your revolving credit limit.

 

What does your credit utilization affect?

There are five main factors that are taken into consideration by the credit bureaus when they calculate credit scores among consumers, and credit utilization ratio is one of them. The other four include:

  • Payment history – The most important factor considered in your credit score calculation is your payment history. A history of timely payments is a good thing for your score, while a habit of missing payments can bring your score down.
  • Length of credit history – The longer your credit history, the more that lenders have to go on when they assess your ability to secure a loan or line of credit.
  • New credit – Applying for too many credit accounts in a short time frame can be a sign that you’re in financial trouble and can negatively affect your credit score.
  • Credit mix – Having a variety of debt accounts that you’re paying diligently shows that you’re able to handle different types of credit, which will reflect well on your credit score.

As already mentioned, credit utilization weighs heavily on your credit score. If you consistently spend too much of the credit you’re given, your credit score could suffer. And if any of the other four factors involved in your credit score calculation are problematic, your credit score could really take a major hit.

 

How does credit affect consumer financial health?

With poor credit, a number of areas of your financial life could suffer:

  • Your ability to secure a loan or credit will be weaker (ie. obtaining a mortgage or car loan will prove to be more difficult)
  • If you are approved for a loan, the interest rate you’ll be charged will likely be much higher than it would be if your credit profile was healthier
  • You could find your insurance rates higher
  • Getting a job might be more difficult
  • Securing cell phone contacts and utilities might be more difficult.

 

How to fix your credit utilization

There are a handful of things you can do to repair your credit utilization, including the following:

  • Don’t spend any more than 30% of your credit limit
  • Call your credit agency to request an increase in your credit limit
  • Spread your purchase over different credit cards (if you have more than one, but don’t apply for new credit cards for this purpose)
  • Pay your credit card balances in full (or at least make much more than your minimum payments);
  • Pay your credit card twice a month
  • Keep your balance low at the end of a billing period so the balance that shows up on your credit bill will be lower.

 

Final thoughts

Your credit score plays a crucial role in your overall financial health that inevitably affects many areas of your life. And among all the factors that affect it is your credit utilization ratio. If your ratio is very high, it could be pulling down your credit score.

In this case, you’d be well-advised to take steps to bring that ratio down to improve your credit score. If you’re having trouble giving your credit score a boost, give Loans Canada a call. We’ll help put you in touch with the appropriate credit counsellors who can help you get your credit back up to where it should be and help you improve your overall financial health profile. Get in touch with Loans Canada today!

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