Credit Utilization: An Important Part of Your Credit Score

It's true that the most important part of your credit score is your payment history. If you want to maintain a good score, you need to pay your bills on time, and in full. However, this doesn't mean that you should overlook your credit utilization. Indeed, you want to make sure that you keep your credit utilization in mind as you work to improve your credit score so that you can be ready to get the lowest interest rate on mortgages, and qualify for the best Canadian credit cards.

What is Credit Utilization?

Credit utilization is the amount of available credit you are using. Your total credit card balances is divided by your total credit card limits. So, if you have three credit cards with balances of $1,000, $2,000 and $2,500, and your limits on those cards are $1,500, $2,500 and $3,000, your credit utilization would be figured by dividing $5,500 (your total balances) by $7,000 (your total credit limit). The answer, in this case, is 79%.

The recommendation is that you keep your credit utilization to 30% or less. So, as you can see, a credit utilization of 79% is rather high. Since credit utilization is right around 1/3 of your credit score, you can see how it might be important to work on paying down some of your credit card debt if you have a high utilization.

Pay Off Cards One at a Time? Or Get Each Card Down to 30%?

Many consumers want to know what tactics they can use when paying down credit cards. If you are trying to pay off debt in an efficient manner, many suggest that you order your debts according to interest rate. That way, you can pay down the debt with the highest interest rate first, and pay less overall in interest charges. And, as you move down your list, your pay off will accelerate, since your later payments will go more toward principal.

Others, though, suggest that for a quicker boost to your credit score, you should get each card down to the 30% utilization number as quickly as you can. Technically, of course, it shouldn't matter how your credit card debt is distributed, as long as your totals reflect a lower credit utilization. However, some experts think that it might make a little bit of a difference in your score, and that your best bet is to work on getting each credit card to the 30% mark before you completely pay off a card -- if your goal is to raise your credit score quicker.

In any case, the important thing is to reduce your debt. You can do that with proper planning, and a commitment to paying off your credit cards as quickly as you can.

Image source: Pne via Wikimedia Commons

This post was included in the 13th carnival at Living Simplistically, and in the Carnival of Financial Planning at Good Financial Cents.