In the quest to boost your credit scores, the question of whether or not you should open new lines of credit can be confusing. If you’re aiming to be a superstar with a credit score north of 700, the truth is that you will need to have access to a relatively high overall credit limit.
The catch? You have to keep your credit utilization ratio low—which means you shouldn’t use too much of the credit that’s accessible to you.
“Credit scoring models reward you for having a high credit limit relative to the amount of credit you actually use. Generally, it’s better to use less than 30% of your available credit,” says Susan Henson, consumer credit expert at Experian. “This ratio—your available credit compared to the amount you spend—is also known as known as credit utilization, and a low ratio shows lenders you can control your spending and manage your credit.”
How Does My Credit Utilization Ratio Work?
Your credit utilization ratio is simply calculated by dividing the amount of credit you use on a regular basis—even if you pay your credit card balances off every month—into the total amount of credit available to you.
So say you typically charge about $2,000 regularly and pay it off at the end of the month, and you have no other ongoing credit card balances. If the overall credit limit added between all your credit cards is $10,000, your credit utilization ratio is at 20%. But if you regularly charge $4,000, pay it off monthly and your overall credit limit across all your cards is still $10,000, then your credit utilization ratio is at 40%.
Even though the amount of money you spend on a credit card in each scenario is the same, the utilization ratio is very different based on the amount of credit you have access to. There’s no firm rule of thumb when it comes to utilization ratios, but generally, experts suggest that to maintain a good credit score, keep your utilization ratio under 30%. For the very best scores, you’ll want to keep it under 10%.
How Do I Get A Better Credit Utilization Ratio?
Improving your credit utilization ratio is pretty simple: You either need to lower your credit card spending or increase your credit limit. In order to figure out your best course of action, start by looking at your average monthly credit card spending.
Pull all your credit card statements from the last year, add up the monthly statement balances and divide by 12. That should give you an idea of how much you typically charge each month. (Note that if there are months when your balance is extra high, your credit score will take a hit if your limits are not high enough to maintain a ratio of under 30%.)
Then, you’ll want to check the credit limits on all your credit cards and add them up. If your total credit limit is more than 10 times your average monthly balance, you don’t need to worry. You have enough credit to maintain good credit scores.
If that’s not the case, you may want to consider applying for a new credit card or request a credit limit increase on existing cards until you reach the ideal credit utilization ratio. Because you won’t necessarily know what credit limit you will get when you open a new card, it might take a few attempts to achieve your perfect credit limit.
Won’t My Credit Score Drop If I Open New Credit Cards?
It’s true that your credit scores take a small, temporary hit when lenders make a hard inquiry on your credit report in processing a new credit application. But you generally recover from such inquiries very quickly, and an inquiry only impacts your FICO® Score for one year. If you maintain good credit habits, like paying your bills on time, not carrying a balance and keeping your utilization ratio low, your score will recover quickly. It’s a short-term trade-off for a long-term goal.
Opening a new card or two to increase your total available credit limit is a bit like getting “credit score insurance”—the more credit that’s available to you, the lower your utilization ratio, even in the event that you have to charge more than usual occasionally.
Of course, the danger is that when more money becomes available to people, it often gets spent. So it’s important that if you do increase your credit limit, you don’t see it as a license to spend more. If you do that, not only will you still have high credit utilization ratio, but you’ll also likely find yourself deeper in debt.