How to consolidate debt and improve credit utilization ratio
Credit utilization ratio is not a much common term. But, it can have a great impact on your credit score, and that too negatively, if it’s high.It is also referred to as the debt-to-credit ratio, balance-to-limit ratio, or even debt-to-limit ratio.
So, let’s see what these terms mean and then we will discuss how to consolidate debt and improve credit utilization.
Credit utilization ratio - What is it?
It represents how much credit you’ve used from your available limit. It is an important component of your credit score.
Both the FICO and Vantage credit scoring models give importance to this factor.
What is a good credit utilization ratio?
Ideally, the best ratio can be 0%, that is, you’re not using your credit cards at all. But, that won’t help you to improve your score.
The reason being that one of the components of your credit score is types of credit you use. It is better if you use your cards responsibly. That is, use the credit cards and pay the bills at every billing cycle.
However, you shouldn't use more than 30% of your credit limit. Anything beyond this can affect your credit score negatively.
If the ratio is too high, it can drop your score more.
Therefore, even if you pay your entire outstanding bills every month, don’t use more than 30% of your credit limit, in any of your cards, at any point in time. If required, you can pay a portion of your bill and swipe your cards again, so that your utilization ratio is always within 30%.
How can you calculate your debt-to-credit ratio?
It is easy to calculate your debt-to-credit ratio.
List and add your total available credit limit. Now, list and add your total outstanding balance. Then, divide your total balance by your total available credit limit.
The ratio is usually expressed in a percentage.
Total credit limit -> 10,000
Total balance -> 2,000
Credit utilization ratio -> 20%
In this regard, I would like to mention that you can use a credit utilization calculator to know where you stand. Doing so, you won’t have to do the calculations on your own and the calculator will do it for you.
How credit card consolidation can help you repay debts?
Credit card consolidation can help you repay your multiple bills just by making single monthly payments.
You can pay off credit card debts by:
a Enrolling in a consolidation program
You can sign up with a consolidation company to repay your bills under complete professional guidance. All you have to do is make a single payment to the company and it will disburse the amount amongst your creditors as per agreements.
b Taking out a personal loan
A consolidation loan, similar to a personal loan, is what you can take out and repay your existing bills. Then, you just have to manage the new loan and make the fixed payment every month, to repay it within a stipulated period.
c Opting for the balance transfer method
This option can be suitable if all you have is credit card debt. You can use the smallest interest rate card or take out a new card for the purpose. You transfer all other credit card balances to that card and repay the balance as fast as possible at a lower rate.
When you repay credit card debts with the help of consolidation, you pay off the bills in full. So, the account statuses get updated as “Paid in Full”. It is a positive addition to your credit report. Therefore, your score will improve over time.
Your future creditors will also view this positively as you’ve cleared all outstanding debts in full, that is, made the required payments.
How paying back debt can help you improve your credit utilization ratio?
As I already mentioned, to decrease your credit utilization ratio, you need to repay your debts. So, when you repay credit card debts one by one, your credit utilization ratio keeps on decreasing, thus improving your score.
How can you lower credit card utilization?
When talking about credit utilization ratio or debt-to-credit ratio, you’ll quite naturally think how to improve credit card utilization. One possible way, as discussed, is to consolidate debts and pay them back.
Some other ways are:
a Apply for a new credit card
You can take out a new credit card to improve your credit utilization ratio instantly since you’ll get a significant amount of credit limit, which will decrease your debt-to-credit ratio.
However, it’s not that simple.
When you apply for a new card, there will be hard inquiries, which can reduce your score to some extent. In addition to this, you might be tempted to use your new card when you get a fresh credit limit.
However, it won’t be that easy to take out a new credit card with suitable terms and conditions if you already have a significant amount of credit card debt or other debts, especially, unsecured ones.
b Ask to raise the limit on your existing cards
Without taking out a new credit card, another way is to ask your creditors to increase the credit limit on your existing cards.
It will reduce your debt-to-limit ratio instantly.
However, make sure you don’t swipe the cards for big amount until you repay the existing balance. And, after you repay them, don’t close them.
Keep the cards open and it’ll increase your credit score.
Another important thing you should know is that if you’re concerned about your credit score, then you might have to wait for about 30 days.
You must be thinking how good it would have been if your score could be instantly increased after paying back a credit card balance? But, it’s not like that.
Usually, the credit card companies report account activities to the credit bureaus once a month. So, you might have to wait for a month to get the improvement reflected in your credit reports as well as score.