DOES LOAN UTILIZATION AFFECT CREDIT SCORE? Your credit utilization rate measures your revolving account balances against your credit limits. Naturally, your ratio can affect your credit scores. Low occupancy can improve your credit scores, while high occupancy can hurt them.
For that reason, it pays to understand exactly how credit utilization rates work and how they affect your credit. Although the math is simple, you just need to know how to add and divide, but it’s not always clear which numbers to use.
How The Credit Utilization Rate Works
Credit utilization refers to the percentage of your total available revolving credit, such as credit cards and personal lines of credit. Installment loan balances, including personal loans, are not part of credit utilization calculations, although they can affect your credit score.
You have two usage percentages: your account usage and your overall usage. To determine your occupancy rate, credit score models such as FICO divide the reported revolving balance by the credit limit of your card or line of credit. Your total credit utilization ratio is a comparison of all applicable balances and ongoing limits.
Both your overall credit utilization rate and individual account utilization rate can be important to your credit score.
How Does Credit Utilization Affect Your Credit Score?
Credit utilization rates can be an important factor in your credit score. However, the specific impact depends on the type of credit score model and your overall credit profile.
For example, FICO lists rotating usage as a sub-component of the “amount owed” portion of the scoring formula, which can make up about one-third of your FICO score. Meanwhile, VantageScore lists credit usage, balances, and available credit as highly influential on your scores.
In both cases, low utilization, both overall and on individual accounts, is generally better for your score.
As a general rule of thumb, it can be a useful guideline to make sure your overall occupancy rate stays below 30%. However, people with the highest credit scores often have an occupancy rate of less than 10%. One oddity: a low occupancy rate, like 1%, can be better than no occupancy. This is because credit scores are designed to predict how you might repay a loan in the future. A poor utilization rate is simply easier to predict than zero debt.
Lowering your occupancy rate can be one of the quickest ways to improve your credit score because most scoring models only consider your occupancy rate as reported. You may see a quick increase in your credit score if you can afford a high usage charge at once.
Why Credit Utilization Matters To Lenders
Lenders use your credit scores as a benchmark to determine your eligibility for a new account, as well as what rates and terms they offer you. Because your credit utilization can be an important scoring factor, it can directly influence the lender’s decision.
If you have high revolving credit limits and low balances, creditors take this as a sign that you know how to use credit wisely. If you’re borrowing heavily against all of your credit cards and revolving lines of credit, it could be a sign that you’re not as financially responsible as you could be, or that you’re under financial strain.
How To Calculate Your Credit Utilization
You can calculate your credit utilization ratio by dividing the amount of revolving debt you owe by the amount of available credit.
Let’s say you have a credit card and line of credit, each with a limit of $5,000, for a total credit limit of $10,000. You owe $1,000 on the line of credit and $2,000 on the credit card, for a total of $3,000 owed. Given this, your credit utilization ratio is 30%.
There are several important points to consider when calculating the occupancy rate:
- Many credit card issuers report balances monthly, around the end of each statement period or billing cycle.
- The bill for the settlement period can be paid approximately three weeks later.
- Credit score models calculate only the balances listed on your credit reports at the time.
- Due to time constraints, even someone who pays off their credit card balance in full each month can have high credit utilization that affects their credit score.
Keep in mind that to calculate the most accurate occupancy rate, you should check your credit report rather than your current credit card balance. Some credit reports may also include your credit utilization ratio, saving you the guesswork.
6 Ways To Improve Your Credit Card Usage
At the end of the day, only two numbers matter your balance and your credit limit, but there are ways to lower your credit utilization and potentially boost your credit scores.
1. Apply for a credit limit increase.
As long as your balance doesn’t also increase, a higher credit limit can lower your occupancy rate and make it easier to maintain low-interest rates. You can ask card issuers for an increase in the credit limit. However, the application may result in a hard credit check, which may cause a temporary drop in your credit score.
Also check the amount of annual income that you have declared to the credit card company, which can usually be found in your online account. If your income has increased, updating the amount may help you get approved for a higher credit limit or lead to an unsolicited raise.
2. Pay off credit card balances early.
Lowering your credit card balance before issuers report it to the bureaus can also lead to a lower occupancy rate. While the report often occurs around the end of each statement period, you can call your card issuer to confirm the exact timing.
If you have a balance on you, making early payments can also help you save money, as credit cards often accrue interest daily.
3. Spread your expenses over several accounts.
While spreading your costs across multiple accounts won’t lower your overall utilization rate, there may be times when you max out one of your cards. The occupancy rate of your accounts can also be a scoring factor. So avoiding a single account with high credit utilization can help your credit scores.
4. Open a new credit card.
Opening a new revolving credit account, such as a credit card, can increase your total available credit. Keep in mind, however, that a new card may have an annual fee and increase the temptation to spend, rack up debt, and increase your usage rate rather than help.
5. Keep your credit cards open.
If you have a credit card that you’re considering closing, you may want to keep it open to keep more credit available.
Of course, if there’s a specific reason you don’t want the card, such as your annual fee or concerns about overspending, closing the card may be a better option. But if the card doesn’t have an annual fee and you rarely use it, keeping it open could benefit your credit scores.
You can even use the card for a small monthly bill and enable automatic payments to make sure you pay on time and prevent your account from being closed due to inactivity. Or set a calendar reminder to use the card every few months (and another to pay off).
6. Becoming an authorized user of someone else’s card.
Credit card issuers can report accounts to credit reporting agencies under both the primary and authorized username. As an authorized user, you can take advantage of the additional credit available.
But remember: as an authorized user, you also give up some control. For example, if the primary cardholder has a high occupancy rate, this may also show up on your credit report. If you don’t pay on time, your credit scores can also take a hit.
Does Applying For A Personal Loan Affect Your Credit Scores?
A loan application can lead to a difficult investigation. This happens when a bank or other lender reviews your credit report as part of an application review. A thorough investigation can damage your credit score and stay on your credit report for up to two years. But how much your scores are affected may depend on your specific financial situation.
Having too many questions on your credit report, especially within a short period, can also have consequences, says the Consumer Financial Protection Bureau (CFPB). And if your credit report shows multiple credit applications in a short period, it may appear to lenders that your finances have changed for the worse.
You can avoid unnecessary credit questions by checking your credit reports and scores before applying. As the CFPB points out, checking your credit reports and scores can give you a better idea of whether you’ll be approved. In general, the better your credit scores, the more likely you are to be approved.
You may also consider going through a pre-approval process. Seeing if you are pre-approved before applying is no guarantee that your loan application will be successful. But maybe it gives you a hint. And it counts as a soft inquiry, which doesn’t affect your credit scores, according to the CFPB.
How Can a Personal Loan Hurt Your Credit Score?
Personal loans can be reported to credit reporting agencies. If yours is, it can be taken into account when your credit scores are calculated. That means a personal loan can help or hurt your credit scores.
The amount and age of a loan can affect your credit scores. But it’s not just the loan itself that affects your credit scores. The way you manage the loan also affects your credit scores.
It is important to pay on time and avoid late or missing payments. As the CFPB points out, your payment history plays a huge role in your credit scores. And the better your payment history, the better your credit scores. But falling behind or missing payments can affect your credit score.
How Can a Personal Loan Help Your Credit Scores?
If your loan is reported to credit reporting agencies, the loan can help your credit scores. But remember that not only the loan itself but also how you handle the loan can make a difference.
Here are some ways a personal loan can positively impact your credit score. However, keep in mind that many other factors affect your credit scores. And you need to keep an eye on all of them if you want to get and maintain good credit scores.
If you pay on time
By paying on time every month, you can build a positive payment history. And according to the CFPB, good payment history can help you improve your credit scores or maintain good credit scores.
If you need help tracking your bill payments, you can set up a budget, automatic payments, or reminder alerts.
If you diversify your credit mix
A personal loan is a form of credit known as an installment loan. With a personal loan, you borrow money and pay it back in equal installments over a fixed period.
But a credit card bill is an example of revolving credit, meaning it can be used and paid off repeatedly. So if your only source of credit has been credit cards, adding a personal loan would diversify your credit mix. And a diverse credit mix can improve your credit scores.
However, getting a loan still means taking on more debt. And a good credit mix probably won’t help your credit scores if you can’t keep up with your payments.
If it helps you lower your credit utilization rate
Your credit utilization ratio is a measure of how much of your available credit you use. To get a good credit score, the CFPB recommends keeping your credit utilization below 30% of your available credit. But credit usage only applies to revolving credit accounts such as credit cards, personal lines of credit, and home equity credit lines.
A personal loan does not take into account the use of your credit because it is a form of installment credit, not a revolving credit. But using a personal loan to pay off revolving credit debt can reduce your credit utilization. And according to the CFPB, keeping your credit utilization low can help you improve your credit scores or maintain good credit scores.
Keep in mind that reducing your credit usage won’t help your credit scores if you don’t responsibly manage the other factors that affect your scores.
Manage your credit usage responsibly
Keeping track of your credit card balances, credit limits, and statement period end dates can be wise activity from a personal financial perspective. The most active way to manage your occupancy rate is to make payments before issuers report your balance to the credit bureaus.
However, you can also keep your occupancy rate low by limiting your spending, for example by budgeting and reducing bad spending patterns, or by paying cash. It’s generally best not to use credit cards for large purchases if you can’t pay the entire balance on your statement. This helps avoid high-interest credit card debt.
Frequently Asked Questions About Does Loan Utilization Affect Credit Score
Do you have any questions? Some of these frequently asked questions may provide the answer.
When is the credit consumption calculated?
A credit utilization rate is calculated when a credit score model analyzes a credit report. Changes to your credit report, such as a newly reported credit card balance, may result in a different occupancy rate.
Does using credit matter if you pay in full?
Yes, it remains important. Even if you pay your credit card bill in full, you can still have a high occupancy rate that can hurt your credit score. Credit card balances are often reported weeks before the due date of the account, and the reported balance affects your occupancy rate.
How does credit utilization affect your credit score?
Credit utilization rates can have a major impact on your credit scores. The specific number of points depends on the scoring model and other information on your credit report. But if you have a high occupancy rate, lowering it can be a way to improve your credit scores.
What is a good credit utilization ratio?
No specific point at which an occupancy rate goes from good to bad. It can be a helpful rule of thumb to keep your overall occupancy below 30%, but the lower the better.