25
Aug

credit limits

Guest article from the Better Credit Blog.

It sounds counterintuitive, but getting another credit card can improve your credit score.

Adding another credit card to your wallet or purse will put a higher credit limit at your disposal, which could be tempting to spend. The trick, however, is to not use that extra available money, but to let it remain accessible so that it improves your credit score.

By not being used, the higher credit limit will help lower the “credit utilization rate,” which is used to help compute a credit score.

There are downsides and upsides to increasing a credit limit. One of the downsides is that a higher credit limit could tempt you to spend it. If you can get over that obstacle, and pay your credit card bills on time and in full each month, you can improve your credit score a lot by getting another credit card and increasing your credit limits.

The amount of money owed on credit cards accounts for about 30 percent of a typical FICO credit score, according to Better Credit Blog. Any moves you make to your credit limit fall into this category and account for part of that area of a credit score.

Your credit limit is used to determine your credit utilization rate — the amount of available credit you’re using when your score is calculated. The rate is determined by simple math: Dividing an account’s outstanding balance by its credit limit. The lower the utilization rate you have, the more it can improve your credit score.

Suppose you have a $20,000 credit limit and a $10,000 balance. Divide the $10,000 balance by the $20,000 limit to get 0.50, or a 50 percent credit utilization rate.

In the same example, increase your overall credit limit by $10,000 to $30,000 and maintain a $10,000 balance, and the credit utilization rate drops to 33 percent.

A rate of 25 percent is preferable to improving a credit score, meaning you want to use no more than 25 percent of the credit available on a credit card. For a credit limit of $20,000, that means using up to $5,000 of it.

Credit utilization has been found to be predictive of future repayment risk, according to MyFico. That’s why it accounts for so much of a credit score and why lowering the rate by increasing the amount of available credit can help raise a credit score by a significant amount. The thinking behind using credit utilization as a predictor of repayment risk is that the higher your utilization rate is, the greater the risk that you’ll default on a credit account within the next two years.

Low credit card balances will reduce the credit utilization rate, and will give you an opportunity each month to improve your credit score because that’s how often credit card balances are usually reported to the credit bureaus.

Drawbacks of increasing credit limits

Another way to boost your credit score is to keep your credit card balances low relative to their credit limits. This will improve your credit utilization rate without having to take on additional credit.

But if you do want to increase your credit limits as a way to raise your credit score, then you should be aware that opening new credit cards for this reason alone could backfire. It could lower your credit score by adding hard inquiries to your credit report.

Inquiries remain on your credit report for two years, but they can only impact your credit report for the first 12 months. And only then can they affect your credit score if they’re a hard inquiry.

A hard inquiry is when a lender pulls your credit report as part of your application for credit. Soft inquiries are when you pull your own credit or a creditor pulls your credit without your permission. Soft inquiries don’t negatively affect a credit score.

If multiple hard inquiries are pulled on your credit report in a month — such as when you’re shopping at various lenders for a mortgage — they’ll count as only one hard inquiry if done within 30 days.

You don’t even have to apply for a new credit card to get a hard inquiry. Just asking your current credit card provider to increase your credit limit can result in a hard inquiry that could hurt your credit score.

A single hard inquiry shouldn’t hurt your credit score, but having three within 12 months could ding your credit score a little.

You can also improve your credit score by not applying for any credit increases or applying for new credit for a year, meaning you won’t have any hard inquiries on your credit report.

Other negative items can hurt a credit report a lot more than a few hard inquiries. Collections and late payments can harm a credit report more, and you should get a copy of their credit report at least once a year to check it for inaccuracies and remove wrong information, including hard inquiries that should no longer be listed or aren’t yours.

A credit report, just like a credit card bill, should be carefully looked at for accuracy. Otherwise, your credit score could drop fast.

Learn how you can start repairing your credit here, and carry on the conversation on our social media platforms. Like and follow us on Facebook and leave us a tweet on Twitter.