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Credit utilization, or the total credit amount you are using, is an essential component of how your credit report is scored. It is also one of the few factors you can change fairly rapidly.
Certain negative marks can stay on your credit profile for up to seven years; however, several credit grading models only consider the most recently reported utilization rates.
Therefore, you can rapidly improve your scores by paying down credit card balances to free up credit utilization.
Better scores can mean additional loan and business credit card opportunities and lower interest rates. Let’s take a closer look at other reasons credit utilization is important for small businesses.
There are two kinds of credit scores firm owners like you are concerned with: your personal credit score and business credit score.
Your personal credit score is weighed heavily when you first start your company. Because lenders are unsure whether your company will be around long enough to pay them back, they typically require a personal guarantee to obtain a business credit card.
Additionally, the three major business reporting agencies, Equifax, Experian, and Dun & Bradstreet, use your personal score, your credit utilization ratio (CUR), and other factors to calculate your company’s credit score.
In general, high credit utilization ratios can hurt both personal credit scores and small business credit scores.
While it makes sense to use a modest percentage of your credit to establish your company’s credit history, utilizing too large a portion of your available credit can cause problems.
The reason is that FICO (one of the most commonly used scoring methods) slices your credit data “pie” into five categories:
As you can see, credit utilization makes up nearly a third of your score. A high utilization tells lenders you may be going through financial difficulties and may be a lending risk. This results in damaged credit scores and typically prevents lenders from extending additional credit.
Maintaining a low overall utilization percentage may significantly offset the negative impact of a high balance-to-limit ratio on any single card. That’s why experts at Experian and elsewhere warn against shutting down inactive card accounts, especially if your credit score is low. Closing that open account may elevate your total credit utilization rate.
It probably seems like a good idea to have no credit utilization. After all, less is more, right?
Frequently repeated financial advice is to keep your credit utilization under 30%; however, today, more financial experts advocate maintaining an even lower CUR, but not too low.
It turns out that while a 0% utilization is more acceptable than a high CUR, it does not help you as much as having a ratio that does not exceed 25%. And if you want an excellent score, keep it under 10%.
The bottom line is that your company must keep its credit utilization ratio as low as possible without touching 0%. This will allow you to build and improve your business credit, which in turn will increase your eligibility for obtaining a business card with the most valuable reward benefits.
A great way to boost your credit score in a short time frame is by lowering your credit utilization. Bankruptcy or late payments can take months or years to drop off your score; however, you can dramatically improve your score by paying all of your personal or business credit cards down in one month.
Here are other ways that can help you drop your credit utilization well under 30%:
Using more than one card will give you several accounts with a lower utilization instead of one account with higher utilization. This is especially helpful if your spending on any one card takes your utilization over 25%.
If you are charging a single item, you may want to find the money to cover part of the payment in cash to help you prevent maxing out the card.
Nevertheless, this method may not always work. It is contingent on the model used to score your credit. Some models look at your overall credit utilization, while others look at the utilization of individual credit cards.
Making two or more card payments in a month ensures your credit balance remains in check. Credit card issuers usually report purchase activity to the credit bureaus monthly. If you pay some or all of your balance prior to that date, your credit utilization should go down.
If you recently got a raise and have a stellar credit history, you may want to ask your card issuer for a limit increase. Keep in mind that this may result in a hard credit inquiry, which can lower your score for a time.
Because CURs reflect how you utilize revolving credit, you may want to take out a personal loan and pay off your credit cards. This effectively transforms the debt into an installment loan with the added benefit of having a lower interest rate than your business or personal credit cards.
There are, however, a few drawbacks to this method. First, you have to be eligible for the loan. Next, you may have to pay an origination fee on the borrowed money. Furthermore, to receive the lowest interest rates, you’d better have an excellent credit profile. If your credit is poor, or even average, you may wind up paying more interest on your personal loan than you did on your credit cards.
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