Debt Management: Understanding “Credit Utilization Ratio”

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You’ve ordered copies of your credit reports and are considering closing several credit card accounts that you haven’t used in a few years. Here are some benefits of closing such accounts:

• Reducing exposure to credit card fraud: Chances are you don’t pay much attention to credit card accounts you’re not using. Closing inactive accounts reduces exposure to fraudulent use of your accounts and related credit problems.
• Avoiding inactivity fees: Credit card companies have responded to recent  regulatory legislation by raising some fees and adding others. You may be assessed an inactivity fee for not using your cards. You may be better off using each card you have occasionally to avoid these fees because closing active accounts reduces your credit utilization ratio, which can lower your credit scores. Here’s how your credit utilization ratio is calculated and how it works.

Credit Scoring and Common Sense: Not Always a Package Deal

Credit scoring doesn’t always work in the ways we expect it to. Let’s say that you have credit cards that you don’t use, and think it’s responsible to close the accounts and avoid potential fraud. Not so fast. Closing inactive accounts reduces the total amount of credit extended to you, and this lowers your credit scores. The credit utilization ratio is calculated by dividing the amount you owe on credit by the total credit issued to you. Here’s an example. Tom has three credit cards with credit lines totaling $15,0000, and he owes $5000, his credit utilization ratio is approximately 33%.  He decides to cancel one of his credit cards, which has a credit line of $5000. This reduces Tom’s available credit to $10,000. His credit utilization ratio now increases to 50% because he owes $5000 against a total credit line of $10,000. Credit experts recommend owing no more than one third of your available credit lines, so increasing his credit utilization ratio from 33 to 50% could cause Tom’s credit scores to drop.

Opening and Closing Credit Card Accounts: Open a New Account First

It may be tempting to close accounts when frustrated or angry. Instead, consider these alternatives :

• Using balance transfers: Judicious use of balance transfer offers can help eliminate balances with high finance charges if you plan ahead. Read the fine print to determine the amount of transfer fees. If the transfer fee is less than the finance charges you’re currently paying, transfer your balance and budget to pay it off before the rate increases.
• Opening new credit card accounts: If you want to close an account, consider opening a new credit card account to replace the old one. Aim for a new account with a lower rate and fees than the one you’re closing. Avoid opening multiple accounts because this can damage your credit scores.

If you’re having problems with credit card debt, consider getting debt help. Debt consolidation through credit counseling can help with debt management.

Post written by Karen Lawson

2 Responses to “Debt Management: Understanding “Credit Utilization Ratio””

1. Debt Advice and Support Says:
   April 26th, 2010 at 1:42 am

   yes,Credit card companies have responded to recent regulatory legislation by raising some fees and adding others. You may be assessed an inactivity fee for not using your cards. You may be better off using each card you have occasionally to avoid these fees because closing active accounts reduces your credit utilization ratio, which can lower your credit scores.<a href=”&quot;http://debtadvicesupport.com&quot;” rel=”&quot;dofollow&quot;”>Debt Advice and Support</a>

2. klawson Says:
   May 2nd, 2010 at 3:54 pm

   Thanks for your comments.

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