By Obioha Okereke, College Money Habits
For me, credit has been one of the more confusing aspects of personal finance. While there are plenty of tips and tricks to boost your credit, there are also habits that can cause your score to drop and many of them are not so intuitive.
Learning about Credit Utilization
One of the biggest lessons I learned around credit is to avoid using more than 30% of your total available credit. Here’s a short story on how I came to know this.
In 2019, at the age of 22, I went on my first “solo” trip to Pasadena, California. I use air quotes because I traveled with my brother, but it was my first trip without my parents. This meant that for the first time, I would be responsible for paying for my airfare, food, hotel and transportation.
Looking to boost my credit score, my brother and I decided that I would charge our hotel bill to my credit card. My plan was to use my credit card for the hotel bill, then pay off my statement the following day so that I did not leave a large balance outstanding for too long. The end goal? I expected to see a large jump in my credit score as a result of charging a significant amount and paying it off almost immediately.
This didn’t happen.
At the time, my credit limit was $1,000. The hotel bill came out to roughly $838 (yes, I still remember). So, I followed my plan and charged our bill to my card, paid it off the next day, and waited to see the increase in my score.
Can you guess what happened instead?
When I received my updated credit score, I found that my score had dropped by over 30 points. To this day, it is the single largest drop to my score over a 1-month period. Confused and angry, I began to do a lot of research into why my score had decreased despite the fact that I had paid off my balance so quickly. In the end, I found that when you use more than 30% of your available credit, it will likely cause your credit score to drop. I had used over 80%.
“The general rule of thumb with credit utilization is to stay below 30%. This applies to each individual card and your total credit utilization ratio. Anything higher than 30% can decrease your credit score and make lenders worry that you’re overextended.”
I did, however, have an amazing vacation! Overall, it was a great learning experience, and I have since improved my score from 730 to 803 over the past three years.
Tip: To help boost your score, try to keep your utilization ratio in the single digits!
Raising My Credit Limit
Since that experience, I have used my credit card only for items I know I can afford and that don’t exceed 30% of my total utilization. About a year ago, I increased my credit limit.
I simply called my lender, Wells Fargo, and said “I would like to increase my credit limit.” To be honest, the only question I can remember being asked was, “What is your annual income?” After answering that question, my credit limit was increased from $1,000 to $10,000.
Raising my credit limit allows me to use my credit card for hotel purchases, like my Pasadena trip, while staying below 30% of my total utilization.
Increasing your credit limit can be risky as it gives you immediate access to a large sum of money. My advice, if you are going to seek a credit limit, make sure that you will be able to afford to pay off your card. The last thing you want to happen is that you increase your credit limit, increase your spending, and then get stuck in a cycle of late payments.
When you request a credit increase, creditors and lenders will look at several factors including:
- Your existing credit score.
- Whether you have ever maxed out your credit card.
- Whether you have had any recent changes to your income.
While increasing your credit limit can help you reduce your overall credit utilization, it has plenty of risks too. Before increasing your limit, make sure you have a budget and a game plan for paying off your debts.
Tip: To help manage your credit, try creating a spreadsheet of all your cards that includes their balances, limits, and your credit utilization ratio. Also, regularly check your credit accounts to track your spending and pay down cards if you get close to approaching 30% utilization.
Want to learn more about boosting your credit score? Check out 5 Behaviors to Increase Your Credit Score.
If you have any questions regarding these personal finance resources and/or general questions about managing your personal finances, contact Obioha Okereke from College Money Habits at firstname.lastname@example.org
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