If you’ve ever been denied credit when you felt like your credit score was good enough to be approved, then you might want to take a look at your utilization. Your utilization makes up about 35% of your overall credit score, but even if your credit scores are in the excellent range, you may still be denied credit based on heavy utilization.
So what exactly does utilization mean?
Simply put, credit utilization is how much of your available credit limits you are currently using. If you have $10,000 in credit limits and you have used $5,000, then you have a 50% utilization rate. That’s considered heavy usage, and it’s a sign to potential creditors that you might be a credit risk.
Why is a high utilization rate bad?
Because using that much of your credit makes you seem like you cannot meet your living expenses without using credit. If you’re carrying that high of a balance on your credit cards, then lenders believe you are either living paycheck to paycheck, or you’re spending more than you are earning. Either way, it’s a bad sign to potential lenders. It looks risky.
Most lenders prefer to see your utilization under 30%, and ideally, you want to have your overall utilization under 10%. This can be difficult if you have small credit limits because even the smallest purchases can eat up a huge percentage of your limit. However, you can still use your cards without lenders seeing high utilization if you remember to make payments right before each due date - because this is when your lenders report your balance to the credit bureaus.
How can I lower my utilization?
The most obvious way would be to simply pay down your debt. But there are some other other tips and tricks. For example, you can find out when your statement closes each month and pay your balance down below 10% before that date. Even if you use 100% of your credit limit, lenders will only see the balance you had when your statement posts. This is because your lender will only report your balance at the time your statement is issued to your credit report.
It’s always a good practice to pay your balances in full when you can because you won’t be charged interest until your statement is issued. If you pay in full, you will save money and also keep a low utilization.
Of course, lenders want to see a low credit utilization rate. They don’t make any money if they can’t charge you interest, so carrying a small balance on one or two of your cards at a time is fine.
What's a good utilization to have?
The basic rule of thumb is that you should carry under 10% of your total credit limit as a balance on no more than two cards at a time, and under 10% total overall utilization. This will help you maximize your credit score, and you will look like less of a credit risk to lenders.
What about raising my credit limit?
If you have a high utilization rate and are unable to pay your balances down, but you need your credit score to rise for something like a credit application - you could try applying for credit limit increases with some of your existing cards. Keep in mind that many lenders will pull your credit report before making a decision on whether or not to increase your limit, and that pull could temporarily cause your score to drop by a few points due to a new hard inquiry appearing on your credit report. You will get those points back quickly, but many lenders are also sensitive to inquiries. If you have too many inquiries in a short period of time, you could get denied for that as well.
You can call your credit card company and ask if they will pull your credit before determining whether or not you will be extended a higher credit limit. If they do perform an inquiry, ask if it will be a soft pull or a hard pull. A soft pull will not damage your credit score, and other lenders will not be able to see that it was done. A hard pull will probably cost you around 2-3 points on your credit score and will appear on your credit report when other lenders request a copy.
If you are able to get your credit limit increased, it will help lower your overall credit utilization percentage, which will usually cause your score to rise. How much it rises will depend on a number of factors, but generally it will offset the drop in credit score if there is a hard pull. Just keep in mind that if your lender does a hard inquiry and decides not to give you a credit limit increase, you won’t have a corresponding drop in utilization to offset that pull.
There is one final tactic you can use to drop your utilization quickly, and that is by taking out a debt consolidation loan. This loan will pay off your current card balances and consolidate them into a single monthly payment, however, you must be certain your interest rate on the loan isn’t going to be higher than the interest you’re paying on your credit cards. Additionally, it’s a good idea to try to find a loan that won’t report to your credit unless you default, because simply transferring your balances onto another loan will not lower your overall utilization.