A high credit score unlocks a bunch of benefits. You can get a lower interest rate on any loan and qualify for better financing. Mortgage lenders will look at your FICO score before determining how much money you can borrow and what rate you will receive. Your credit score partially dictates where you live and impacts your life in other significant ways.
That's why it is important to build your credit score over time and make sure you have a good or great score. Financial personality Humphrey Yang recently shared the top tip you can use to boost your credit score.
"Keep your utilization rates low," Yang said in a recent video.
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Keeping your credit utilization ratio in check can boost your credit score and improve your finances. Here's why.
Why Credit Utilization Is Important
The credit utilization ratio is the second most significant part of your credit score. This component makes up 30% of your FICO score, and a good credit utilization ratio will typically result in a good payment history, which makes up an additional 35% of your credit score.
Yang mentions that you should never use more than 30% of your credit utilization ratio. For instance, if you have a $10,000 credit limit, you should never have a balance above $3,000 for that credit line. Yang explains that using more credit can make you appear less trustworthy to the major credit bureaus.
Yang also mentions that the major credit bureaus know that as you get closer to maxing out your credit card, you are more likely to default on the debt. That's why your credit score goes down as you carry a balance, especially if your credit utilization ratio gets above 30%. It's optimal to have a credit utilization ratio below 10% for the best results.
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How To Reduce Your Credit Utilization Ratio
You only have two options to reduce your credit utilization ratio. The first choice is to make on-time payments and gradually chip away at the balance. This is the best way to approach reducing your credit utilization ratio since it requires good financial habits.
The second way you can reduce your credit utilization ratio is by opening new accounts. Your credit utilization ratio is based on the combined limit and balances across your accounts. For instance, if you owe $5,000 on a $10,000 credit line, you have a 50% credit utilization ratio. That's not good. However, if you have a separate $20,000 credit line with no balance, you suddenly owe $5,000 and have $30,000 in available credit across your accounts. That results in a more favorable 16.7% credit utilization ratio.
The only catch with opening new credit accounts is that you will trigger a hard credit check, which will reduce your score in the short run. You should not apply for any new credit accounts right before you apply for an important loan, such as a mortgage or an auto loan.
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Credit Score Growth Is A Long-Term Journey
Your credit score won't go from bad to good overnight. It can take several months before your FICO score picks up momentum. As you continue to apply good financial habits, such as paying off your entire debt at the end of each month, your credit will improve.
Living below your means is one of the simplest ways to maintain good credit. If you can always pay back your bills at the end of each month, you will have an excellent payment history and a 0% credit utilization ratio. The other components of the FICO scoring system will boost your credit score over time as you remain financially disciplined.
Once you have a good credit score, you have to keep up the good money habits so you maintain your good credit score. You just have to stick with what helped you grow your credit score. It gets easier over time.
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