When you apply for a loan, your credit score is extremely important. The lender will check it before deciding whether to approve your application. And if it does, it will use your credit score to set your loan's interest rate.
This makes a huge difference in how much you pay. Let's say you're getting a 60-month auto loan for $30,000. If your score is 720 or higher, you could qualify for a rate of 7.5%, according to recent data from MyFICO. If your score is 650, you could get a rate of 12.7%. That will cost you $4,576 more in total interest.
It's a good reason to get your credit score as high as possible before applying for any loans, including personal loans, mortgages, and auto loans. Luckily, there's a trick you can use to raise your credit score in as little as one month.
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Lower your credit utilization, raise your credit score
There are several factors that impact your credit score. One of the most important is your credit utilization ratio. This is your credit card balances divided by your credit limits. It gets updated every month when your card issuers report the balances and limits on your credit cards.
For example, you have a balance of $8,000 and a credit limit of $10,000. Your credit utilization is 80% ($8,000 divided by $10,000).
That would be a problem. People who have large balances on their credit cards are considered to be a higher risk. A high credit utilization will negatively affect your credit score. As a general rule, it's best to use less than 30% of your credit.
How much of an impact this has varies. Colleagues of mine who have gone above 50% credit utilization have seen their scores drop by 25 to 32 points. That's more than enough to take you down one or two credit score ranges, leading to a much higher interest rate on a loan.
You can use credit utilization to your benefit, though. Because it gets reported every month, it's one of the fastest ways to raise your credit score. By lowering your credit utilization, you could raise your credit score by 25 points or more.
The best ways to reduce credit utilization
If you're in credit card debt, you may have high credit utilization. You can check this using any free credit score service online. These will tell you your current credit utilization. If you don't have a credit score service you use yet, check out The Ascent's guide to how to get your credit score.
If your credit utilization is a problem, the most effective solution is to pay down your card balances. Use any extra savings you have. You'll save on interest by paying off your debt more quickly. And when you apply for your loan with better credit, you'll likely get a lower interest rate.
Easier said than done -- I get it. If you could just pay down your credit card debt, you would've already done that. But there are a few other options that could do the trick.
Ask your card issuers for a credit limit increase
Lowering your balances isn't the only way to lower your credit utilization. You can also try to raise your credit limits. If your balances stay the same and your credit limits increase, then your utilization will decrease.
Credit card companies don't mind if you ask for a higher credit limit. If you've always paid on time, there's a good chance that they'll approve your request. You can ask over the phone by calling the number on the back of your card. Many card issuers also let you request a higher credit limit in your online account.
Let's say you have $6,000 in balances and $10,000 in credit limits across your credit cards. You ask all your card issuers for higher limits and manage to get $15,000 in credit. That would take your utilization from 60% down to 40%.
Pay your credit card bill more often
Your credit utilization is a monthly snapshot. It's based on your card's balance and credit limit on the day it was reported by your card issuer. So if that happens on the 25th, and you made a big purchase on the 20th, your utilization may be higher for that reason.
It can help to make more frequent credit card payments. Some people pay their credit cards twice a month for this reason. When you pay more often, it keeps your balance from getting too high.
You could also contact your card issuer and ask when it reports your credit utilization. When you know the exact date, you can make sure to get your balance as low as possible before then each month.
A smart way to save on a loan
Many of the factors that affect your credit score are time-related. For example, the only way to have a good payment history is to build a long track record of on-time payments. Your credit history is based on how long you've been using credit.
Your credit utilization is different in that it changes every month. So if you want to get a loan soon, try to reduce your credit utilization. It could be the fast track to a higher score and a lower interest rate.
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