I increased my credit limit by $1,400 this morning, and it took the better part of one minute. Who knew something so potentially tricky — asking your bank to potentially lend you a substantial sum of money — could be so easy? Well it is. And not only is it easy, it can be very important for your credit score. Here’s why.
Your FICO score is based on five metrics, each of which are weighted differently: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%) and types of credit used (10%). Unlike in college, where professors offer their grading schemes on your syllabus on the first day of class, your credit card issuer is not required to educate you about how your score is determined. You might reasonably assume that payment history is the most important part of your score, and you’d be right, but it makes up a mere plurality of the total score.
The amount of your revolving lines of credit that you use is the also-ran in this race, at 30% — just 5% less than payment history, making the difference between the two nearly negligible. But this isn’t exactly intuitive. After all, if you pay your balance down, who cares if you max out your cards every month? Card-maxing, however, is generally a habit of those who do not pay their bank back for money they’ve borrowed, or who do so very slowly anyway, or through debt consolidation — it doesn’t signal that you’re in control of your finances, and that is what your credit score is all about. It’s shorthand for lenders and underwriters who need to know what sort of borrower you are, but don’t have the time to get to know you. And because your credit score is updated at irregular intervals, generally speaking, you want to keep your balance low especially if you use your card to finance larger purchases.
For all the personal-finance bloggers who insist that credit cards are only practical when paid off in full at the end of every month, there are probably thousands of Americans who use their cards to finance larger purchases and manage their monthly cash flow. There’s nothing necessarily wrong with that — you’ll spend money on interest, and your credit won’t be perfect — but you certainly don’t want to be carrying a large balance.
In fact, most experts say that 30% of your limit is the highest balance you want to carry on your card. If you’re still using your first credit card, this might be a painfully and impractically low number. Unlike in college, you have a job that actually pays you money now, and you can spend the money on stuff you want, specifically the things that get you far away from your job: airplane flights, hotel rooms, rental cars, etc. But you won’t want to use your credit card to cover a weekend getaway if it might damage your credit score, needlessly.
If you’re at that point in your life, you might consider increasing your credit limit. Counterintuitive as it seems — won’t this just tempt me to spend more money? — it is good for your credit in the long-run. I logged on to my bank’s website, told them what sort of work I do — “Other (Not Listed)” — how much money I make, and how much goes toward my housing costs. It took all of a minute, and I instantly had access to $1,400 that I don’t actually need, don’t actually have, and don’t actually want.
And that’s the point, right there. Credit scoring is needlessly opaque and seemingly arbitrary, but sometimes there is a sound logic to it, even if it isn’t intentional. Raising your credit limit in order to ensure you improve your credit score is an exercise in both planning and restraint. While I plan to improve my creditworthiness through this counterintuitive measure, I also acknowledge and remind myself that I do not actually want this money — I don’t plan on ever spending it.
Of course, things can never be so simple in the world of credit cards. Because I asked for a credit limit increase, my bank did a “hard pull” on my credit report. Unlike a “soft pull,” a hard pull lowers my credit score, but only temporarily. It’s a temporary, minor and inconsequential sacrifice. After all, I’m not buying a home any time soon. And in the long run, it should pay off. Short-term sacrifice — even an abstract one — for long-term gain is exactly what managing your finances is all about, anyway. As weird as credit scoring seems, it has its own logic.