Maintaining a low revolving credit balance has a significant, positive impact on your credit score because your credit utilization ratio is a key factor in your rating. Revolving credit balances mean you can borrow funds as needed up to maximum amounts. Lines of credit and credit cards are common examples of revolving credit accounts.
Fixed vs. Revolving
You can generally borrow money in two ways. One option is a fixed loan where you borrow a set amount and repay it over time through regular monthly payments. The other is a credit line where you have open access to funds with a limit. Fixed loans are useful when you know how much you need and can get a good interest rate. Revolving credit helps in cases where you need to borrow in unpredictable amounts for ongoing projects, education or other needs. The challenge with revolving credit, though, is the temptation to overspend because you have more credit available.
FICO Score Basics
Equifax, Experian and Trans Union are the three major credit reporting bureaus. Each has a rating system based largely on the FICO scoring model established by the Fair Isaac Corporation. FICO includes a number of specific scoring criteria, but centers on five general categories: Payment history, amounts owed, length of credit history, new credit and types of credit used. Payments history and amounts owed constitute 65 percent of the factors, with 35 percent and 30 percent of your overall score, respectively.
Your credit utilization ratio carries much of the influence in the amounts owed category. This is the percentage of your available credit currently in use. For instance, if you have $10,000 in available credit and $3,000 in use, your ratio is 30 percent. Maintaining a ratio at or below 30 percent is generally effective to build a good to excellent credit rating. Your credit on one account and overall credit utilization are both considered. Thus, you should maintain conservative balances on each card or credit line account.
Your credit rating is important when you apply for new loans and want to get a good rate. The reason a low revolving balance and low utilization ratios are important is the perception of lenders. Typically, they assume that if you use a small portion of your available credit, you are in a safe debt position. This makes you seem like less of a risk if they choose to issue new credit to you. Paying down high balances not only helps your score, it puts you in a better position to manage your debt.
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