Don’t Mess Up Your FICO Score: Manage Your Revolving Credit Usage

For most small business owners, personal credit scores will likely be a part of any business creditworthiness evaluation. So it’s important for small business owners to know what they can do to build and maintain a strong personal credit score in addition to a good business credit profile.

Last time we talked about FICO scores, we discussed the importance of managing delinquencies — the first step to building and maintaining a good score. Today, we’re going to share a little inside baseball on how you can manage your revolving credit usage to optimize your FICO score and how lenders (and the credit bureaus) view your personal credit profile.

What Is Revolving Credit?

Revolving credit is a form of credit that replenishes the credit available as it’s repaid. Typically with revolving credit, a credit limit and interest rate is determined by a lender, which allows a borrower to borrow up to that amount on an ongoing basis. The borrower can then repay portions of the balance due when they can, as long as minimum payments are met on certain payment dates. Each payment goes back into the available credit, minus interest and fees. Popular forms of this type of funding include credit cards and lines of credit.

What Is Revolving Usage Percentage?

Your “revolving usage percentage,” or what is known in the credit industry as “revolving utilization,” is the most important factor that influences your personal credit score and the interest rates you can receive. In other words, creditors look at the total amount of credit that’s available to you and how much of that credit you actually use. This will include any personal lines of credit like a home equity credit line you might have in addition to your personal credit cards or other revolving credit accounts.

For example, if you have two credit cards with $5,000 limits, your total revolving credit is $10,000. If you currently have a $1,000 balance on one of them, but haven’t used any of the available credit on the other one, your revolving credit utilization is 10%. On the other hand, if you currently carry a $4,000 balance on both of them, your revolving credit utilization would be 80%. The small business borrower with 10% credit utilization will look like a better credit risk than the borrower with 80% utilization to a potential lender.

What Is a Good Utilization Percentage?

When applying for a business loan (or any loan for that matter), the lower your overall revolving credit utilization, the better in terms of how the potential lender scores your personal creditworthiness. In other words, one of the quickest ways to improve your FICO score is to pay down your credit cards. With that said, what is a good utilization percentage?

• 75%+: Lenders will consider borrowers in this range to be the highest risk.
• 50% to 75%: This utilization percentage looks very risky to a lender.
• Under 50%: If you have high revolving credit balances, your first goal should be to get your utilization under 50%, which is where your risk starts looking more reasonable to a lender. From this point, the further down you reduce it, the higher your score will get.
• 1% to 5%: If your credit utilization falls within this range, you would receive the highest number of points in your personal credit score. This could possibly be even higher than if you had 0% utilization.

Having a balance on your credit cards or other revolving credit accounts isn’t bad. You simply don’t want the balances you carry to be high compared to your credit limits. This is one reason I don’t recommend using your personal credit cards to pay for business expenses if you can avoid it. Doing so will likely increase your utilization percentage and potentially reduce your personal credit score, even if you pay the balances off at the end of every month.

Because the balances on your credit cards can be reported to the credit bureaus at any point in the month, paying off the balances on your due date doesn’t necessarily get reported as 0% utilization. Remember, it’s OK to have a balance on your credit cards as long as you aren’t maxing out your credit accounts every month, or rather, your credit utilization is low.

Three Ways to Optimize Your FICO Score

If you have credit cards or other revolving debt, here are three things you can do to optimize your personal credit score.

• Keep the balances of any credit card, line of credit or other revolving credit account below 50%.
  • When looking at your credit profiles, the bureaus often look at the number of credit accounts that are greater than 50% utilization or the number of credit accounts that are greater than 75% utilization. Because of this, avoid using more than 50% of your credit limit on any individual credit card or credit account. Spread your balance across multiple cards or accounts to do this.
  • If your current situation doesn’t allow you to maintain utilization below 50%, start by getting all your accounts below 75% of their limit and then work toward 50% from there.
• Request higher credit limits on your credit cards.
  • Because the calculation is a ratio, another way to decrease the utilization percentage is to increase the total size of your credit limits.
  • Although this will likely give your credit score a minor (short-term) ding each time you do it, lowering your credit utilization ratio will help you more in the long run. And, if you make all the line increase requests on all of your accounts within a two-week period, they may only get counted as one hard inquiry.
• Do NOT close any accounts.
  • Despite the common misconception that your creditworthiness will look better if you have fewer accounts, this is not the case. This may have been true a few decades ago, but is no longer correct. Most individuals with the highest FICO scores today have a lot of credit available to them and their utilization is very low. In other words, they use a very small percentage of the credit they have available to them.
  • Leave your revolving accounts open, even if you no longer use them. The zero balances will likely even help you, as will the age of the accounts.
  • It’s a good idea to make a purchase using your credit card once a year to make sure the account doesn’t get closed due to inactivity.
  • If you have a credit card that includes an annual fee, request the lender convert your account to a no-fee account (most lenders will allow you to move to a no-fee account that has less valuable points/miles programs or no perks at all). This way, you can keep the account open without paying the annual fee.
  • NOTE: If you decide to keep all your credit cards open, you will need to regularly monitor activity on the open cards to ensure they are not being used fraudulently. Most lenders offer free alerts you can set up to monitor activity, and the credit bureaus all offer credit monitoring as another option.

Paying down your cards is the single biggest thing you can do to improve your credit utilization ratio and ultimately positively impact your personal credit score. Although taking these actions will benefit your personal credit score, it likely won’t happen overnight — but it will happen. Consider building and maintaining a strong personal FICO score to be a marathon rather than a sprint. While there are no shortcuts, these three tips will help you build a personal credit score that can be a real asset when applying for a small business loan.

^*This article has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for health, tax, legal or accounting advice. You should consult your own health professionals or tax, legal and accounting advisors before implementing any business changes.