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How credit utilization affects your credit score

Posted by Andrew Chan  May 5, 2010 02:30 PM

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If you reduce your credit utilization from approximately 65 percent to 38 percent should that significantly improve your FICO score?

Yes, reducing your credit utilization ratio should improve your credit score but it is difficult to know exactly how much your score will improve because of the many factors used in calculating your FICO score. Credit utilization is the ratio that measures the amount of credit you are using over the amount of credit you have available. It is measured for your credit cards individually as well as in total, across all of your credit cards.

According to the creators of the FICO score, Fair Isaac Corporation, credit scores are calculated with credit data from five categories including payment history, amounts owed, length of credit history, new credit, and types of credit used. The importance of each category (in the calculation of one's FICO score) differs for different people because of their credit history. For example, the "Length of Credit History" category is less important and has less of an impact on the FICO score of someone who has not been using credit for very long compared to someone with a long credit history.

For the general population, the five categories are weighted as follows:
  1. Payment History: 35%
  2. Amounts Owed: 30%
  3. Length of Credit History: 15%
  4. New Credit: 10%
  5. Types of Credit Used: 10%
Credit utilization is one of the factors included in the "Amounts Owed" category. In general, I recommend keeping the utilization ratio below 30 percent for each of your credit cards as well as for all of your credit cards in total. While it is difficult to know exactly what ratio is the best for each person, higher utilization ratios can negatively impact your FICO score.

Canceling an unused credit card with a high credit limit can increase your overall utilization ratio. However, there are many good reasons to cancel an unused credit card especially if it removes the temptation to use it or cleans up or simplifies your personal finances. As with many other financial decisions, you should weight the trade-offs of each decision as they apply to your specific circumstances before doing it. Your credit utilization ratio is an important part of your credit score but it is only one of many pieces used to determine your credit worthiness.
This blog is not written or edited by Boston.com or the Boston Globe.
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D. Abraham Ringer is a CERTIFIED FINANCIAL PLANNER practitioner and a Financial Adviser with Morgan Stanley Global Wealth Management in Boston. He is registered in MA, NH, NY and several other states to which his articles are directed. For more information please visit www.morganstanleyfa.com/ringer
Financial Planning Association™ of Massachusetts has 900 members who specialize in the financial planning process. Many of its members engage in philanthropic pro bono work in their communities, recommend legislation, elevate public awareness, promote financial literacy, and advocate for sound economic and tax policies.
Odysseas Papadimitriou is the founder of CardHub.com, a credit card and gift card marketplace, and WalletHub.com, a personal finance site. He has more than 13 years of experience in the personal finance industry, and previously served as senior director at Capital One.

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