When calculating your credit score, the credit bureaus look at a number of factors in your credit history. One factor that they evaluate is your debt utilization ratio. This is a ratio that looks at the relationship between the amount of credit that you have available to the amount of debt that you have.
Identification
Your debt utilization ratio is the amount of money you owe compared to the amount of open credit that you have on credit lines. For example, if you have $5,000 worth of credit card debt and you have $10,000 worth of credit lines, your debt utilization ratio is 50 percent. The lower your debt utilization ratio is, the better it looks to the credit bureaus. You can change your ratio by paying down your balances.
Closing Accounts
This term often comes into play when people consider closing out credit card accounts. If you're concerned about your credit score, you may not want to close credit card accounts when you pay them off because it lowers the amount of available credit. If you have $5,000 in credit card debt and $20,000 in credit card lines, your debt utilization ratio is 25 percent. If you close a credit card with a $10,000 limit, you've now changed your debt utilization ratio to 50 percent.
Impact
Your debt utilization ratio is one of the most important factors that lenders consider when evaluating you for financing. In fact, this one statistic comprises up to 30 percent of your credit score. The only factor that holds more weight than this is your payment history. This means that if you're interested in improving your credit score quickly, you can pay down your credit card balances to have an immediate impact.
Other Factors
Even though it can hurt your debt utilization ratio, it may be to your advantage to close out a credit card after you pay it off. For people who have trouble with spending too much money, the temptation of an empty credit card sitting there might be too great to overcome. If this is the case for you, you may want to cancel your credit card regardless of the impact to your debt utilization ratio.
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