CREDIT UTILIZATION: This is When Use It or Lose It Doesn’t Apply

by Lee Anderson on February 23, 2013

I always talk about the importance of monitoring your credit profile, but recently I have discovered that there are a few other factors that consumers might not be aware of which ultimately impact their chances of getting approved for credit products.
Talking about credit is not very popular and in fact quite boring, but ultimately it can be the difference between getting approved for mortgage on their dream home and being told, “Sorry, please try again later”.
What Is A Credit Utilization Ratio?
Most people know what a Credit Limit is but not that many people are familiar with Credit Utilization Ratios.
In simple terms, your Credit Utilization Ratio is how much credit you are using in comparison to how much Total Credit you have available.
If the Bank gives you Credit Card with a $5,000 Credit Limit, then that $5,000 is your Total Available Credit.
If in one month, you put $2,500 on your credit card, then you have used up 50% of your $5,000 in Available Credit that month.
Thus your Credit Utilization Ratio is your (Monthly Statement Balance) / (Total Available Credit).
Why Credit Utilization Ratios Are Important
Most of us know the general factors that impact your Credit Score; inquiries, opening new accounts or closing old accounts, not paying your bills on time, etc.
What most people don’t know is that even if you pay your bills in full every month and never miss a payment, your Credit Score will still go down if your Credit Utilization Ratio is too high.
Of course to normal Consumers, this makes absolutely no sense and is extremely counter-intuitive, but unfortunately those are rules of the game.
To a bank, you look extremely risky because you have to use a large percentage of your Total Available Credit.
You have to remember that Banks have millions of Customers who don’t pay their bills on time, so when the Bank sees someone using large percentage of their Total Available Credit, their first thought is, “What if this person doesn’t pay their bill this month”.
What makes things even worse is that if you have ever looked at your Credit Report, you will see that next to your Credit Card Account there is a line that say “Balance”. Occasionally, it will say “High Balance”.
Every month Credit Card Issuers like Chase, send a report to Credit Reporting Agencies like Experian and TransUnion about how much your balance was that month.
Occasionally, they will even report the Highest Balance you have ever had on the Card.
So if for 11 months you only spent $300 and then one month you spend $850, the $850 is what will show up on your Credit Report!
So basically to sum it up, Banks have no problem giving you credit but they will ultimately punish you if you use too much of your Credit Line regardless if you pay your bills on time.
The Ideal Credit Utilization Ratio
Since Banks are extremely concerned about Credit Utilization Ratios, then the next question is what is an ideal Credit Utilization Ratio?
Basically Banks want to see that you are using your Credit Card, but not using it so much that you are a risk.
So to meet that requirement, I’d say ideally you want your Credit Utilization Ratio to be between 5% – 10%, but really the lower the better.
If that’s not possible, you want to stay below 30% because anything above that can significantly impact your Credit Score.
One Other Way To Boost Your Credit Utilization Ratio
While it may sound crazy to only use 5% – 10% of your Total Available Credit (especially if your Credit Limit is really low), there are ways to still use your credit card on a normal basis and boost your Credit Utilization Ratio.
Increase Your Credit Limit
If your Credit Utilization Ratio is based on your (Monthly Statement Balance) / (Total Available Credit), the easiest way to increase your Credit Utilization Ratio is to simply increase your Total Available Credit.
If your Credit Limit is $2,000 and your Balance is $1,000, your Credit Utilization Ratio is 50%.
However if you call and have your Credit Limit raised to $5,000, then magically your Credit Utilization Ratio drops from 50% to only 20%!
To get your Credit Line increased, simply call your Credit Card company and ask if they can review your Account and possibly raise your Credit Limit.
It is that easy!
One thing to point out is that when they are reviewing your Account, YOU DO NOT WANT THEM TO DO A HARD PULL.
A Hard Pull is when they actually pull your Credit Report from the Credit Reporting Agency and look over it.
If you apply for a new credit card, this is the exact same process that they do and these types of “Hard Pulls” can bring your Credit Score down a tad and stay on your Credit Report for 2 years.
Therefore before they do your Account Review, simply ask what type of pull they are going to do, either Soft or Hard. They will know what you are talking about.
A Soft Pull is where they look at your Credit History in their system and make a judgement based on that information.
So if they see for the last two years that you have paid your credit Card bill on time and never had any issues, then that is enough information for them to raise your Credit Limit.
Ultimately every Bank is different.
RECAP
Hopefully for those of you that were not aware of Credit Utilization Ratios, this sheds some light on the topic.
Although Credit Utilization Ratios are important, don’t let it drive you nuts and force you to start paying with cash or your debit card.
If your Credit Utilization Ratio goes over 30%, simply pay down your balance before the Statement comes out!