June is celebrated as National Homeownership Month! It can be an exciting time for a first-time home buyer or a more pleasant experience for a family looking to upgrade to a larger home.
Charlestien Harris
Several factors can affect your ability to purchase a home, such as income, debt, interest rates, loan products, and credit utilization. These are just some of the factors to consider during the home-buying process. Good credit allows the financing institution to release the funds necessary to buy your home.
Credit utilization is defined as the percentage of your total credit used from the total credit available to you. Your credit utilization ratio, generally expressed as a percentage, represents the amount of revolving credit you’re using divided by the total credit available to you. Let’s look at the factors that affect your credit utilization, how lenders use it, and how you can improve yours.
Developing your credit ratio. Lenders use your credit utilization ratio to help determine how well you’re managing your current debt. Lenders typically prefer that you use no more than 30 percent of the total revolving credit available to you. Carrying more debt may suggest that you have trouble repaying what you borrow and could negatively impact your credit scores. To improve your credit utilization ratio, it’s generally best to decrease your outstanding debt. Depending on your situation, it may also be appropriate to consider increasing your credit limits.
Calculating your credit ratio. To calculate your credit utilization ratio, tally your outstanding debt across all revolving credit accounts. Next, add the credit limits of each individual account together to find your total available credit. Once you have these numbers, divide your outstanding debt by your available credit and convert this number to a percentage to get your credit utilization ratio. Here is an example for you to follow: You have two credit cards, Card A and Card B. Card A has a $1,000 credit limit and carries a balance of $350. Card B has a $2,000 credit limit and carries a balance of $500. This means your total outstanding debt is $850, and your total available credit is $3,000. Therefore, your credit utilization ratio is $850 divided by $3,000, which equals 0.28, or 28 percent. This is just under the 30 percent recommended by financial experts.
Improving your credit ratio. There are steps you can take to improve your credit ratio. It’s generally best to decrease your outstanding debt.
Reducing your revolving credit balances. The most efficient way to control your credit utilization ratio is to pay down what you owe. Try making a monthly budget and dedicate any income you can spare to debt repayment. Remember that revolving credit is structured differently than installment credit. With revolving credit, the amount of debt you hold can fluctuate between monthly billing cycles, depending on how often you make charges to the account. So, when you’re working to reduce your credit utilization ratio, try to make payments as soon as you use your credit card.
Increasing your credit limit. Another approach is to increase your total available credit. You can secure additional credit either by opening a new credit card or by asking your lender for a credit limit increase on one of your existing accounts. However, taking out additional credit can come with its own risks. If your ultimate goal is to raise your credit scores, it’s important to keep in mind that requesting an increase in your credit limit might trigger a hard inquiry on your credit report and cause your credit scores to drop temporarily by a few points.
A borrower’s credit utilization ratio will vary over time as you make purchases and payments. The total outstanding balance due on a revolving credit account is reported to credit bureaus at various times throughout the month. Your credit utilization ratio is one of the most important factors used to determine your credit score. You can improve your credit utilization ratio by reducing the amount of debt you have. When you receive additional lines of credit, your credit utilization ratio will also improve as long as you do not use that credit.
Charlestien Harris is our financial contributor, a financial expert with Southern Bancorp Community Partners whose articles are seen in a number of publications around the region.
