The higher your credit score is, the easier it becomes to borrow money when you need to, whether in loan or credit card form. And having a higher credit score could spell the difference between snagging a favorable interest rate on a loan or getting stuck with a higher one.
As such, you may be eager to boost your credit score. You may have heard that paying off some existing credit card debt is a good way to do so.
Five different factors go into calculating a credit score based on the FICO model (the most popular scoring model in the U.S.):
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- Payment history
- Credit utilization
- Length of credit history
- New account
- Credit mix
These factors carry different amounts of weight. But your credit utilization ratio, which measures the amount of available credit you're using at once, accounts for 30% of your credit score.
The lower your credit utilization, the more your credit score might improve. So if you owe $3,500 on your credit cards and your total spending limit on them is $10,000, you're at 35% utilization, which isn't great. If you whittle your balance down to $2,000, you'll be at just 20% utilization, which is far more favorable from a credit score perspective.
Of course, paying off credit card debt is easier said than done. So you may want to take another approach to boosting your credit score.
And there is one fairly easy way to give your credit score a boost. But it's an approach that can also be risky.
When you raise your credit limit
Your credit utilization ratio is measured based on your outstanding balance and total credit limit. If you can't lower your balance, you might still manage to lower that ratio by raising your credit limit.
Credit card issuers will often give you more buying power on your cards if you call and ask. It helps if you're an account holder in good standing. You can also request a credit limit increase following a pay raise. The logic is that if you're earning more, you can afford to spend more (no one ever said that was good logic).
So let's say you owe $3,500 and have a $10,000 credit limit. If you get that limit raised to $15,000, your credit utilization ratio will shrink from 35% to about 23%. That could help your credit score improve in rather short order.
However, this only works if you don't add to your balance. If you take advantage of your higher credit limit and start spending more, you're not going to do your credit score any favors.
In fact, what might happen then is that you not only add to your debt, thereby setting yourself up to pay more interest, but you start to fall behind on your minimum payments. That could really hurt your credit score, since your payment history carries more weight than any other factor in calculating that number. In fact, it accounts for 35% of your credit score -- more than your credit utilization ratio.
And of course, adding to your total credit card balance could also cause your credit utilization ratio to hold steady at a higher level or even increase. That, too, isn't great for your score.
Paying off debt is your best bet
Getting a credit limit increase might seem like the easiest solution for bumping up your credit score. But you'll be doing your finances a world of good by taking the hard way out and working to chip away at your credit card balance.
Even if your outstanding balance leaves you with a reasonably low credit utilization ratio, the longer you carry that balance, the more money you stand to lose to interest. So the sooner you can get that balance paid off, the better.
One thing that could help you pay down existing debt sooner is to do a balance transfer to a new card with a 0% introductory APR. Let's say you manage to get a 0% introductory rate for 15 months. Let's also imagine you cut your spending and perhaps take on a side hustle to drum up extra money. It's conceivable that you could be debt-free in 15 months, and not racking up extra interest on your balance could be your ticket to whittling it down to $0.
Once your balance is down to $0, if you choose to ask for a credit limit increase, so be it. At that point, you've proven your ability to get out of debt and exercise self-control. But until you're in a better place debt-wise, you should really proceed with caution when considering a credit limit increase.
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