It’s no surprise that credit scores are quite vital to any transaction that any adult in Britain makes. From applying for loans and credit to even finding a job, your credit score can determine whether that application of yours will be approved given what financial status your score implies.
However, here’s the thing: that credit score is going to be severely affected by your actions whether you intended to do them or not. Surprisingly, even the simple facts and guidelines that you may now have not known in your credit transactions may be hurting your credit score severely.
As for millions of Brits out there, that one thing that affects their credit scores heavily is the lack of awareness of the 30% Rule.
To really understand how the 30% rule works, it would be better to understand how utilisation ratios in credit work. To put it in the simplest terms possible, your utilisation rate is made up of the available credit you have versus the credit you have already used.
How credit reporting agencies compute this is quite simple. Your credit utilisation is a result of your available credit limit per month divided by the credit you have already used.
For example, your credit card has a limit of £3,000. For that month, you have used £1,500.00 of the available credit. That means your credit utilisation ration for that month is 50%.
Now, here’s the thing that many are not aware of: the credit utilisation ratio actually comprises a major portion of your credit score. The actual percentage will be different from one reporting agency to another but you can be sure that that range is from 30% to 40%.
This is why maxing out on your credit limit tends to hurt your credit score. The bigger your utilisation rate is, the lower your credit score is going to be. That is why it’s common for many credit card holders who maxed out their cards to have scores in between the 400 to 600 range. That means their scores are practically considered poor to beneath the average.
“But…” You think to yourself “I never maxed out on my available credit every month. Why do I always get lousy scores?”. What a lot of people in the UK think is that you only have to make sure that you don’t max out on your credit so that your scores will be okay. So, if you have a £3,000 limit and your spending is just a few hundred pounds below that, then your score won’t be negatively affected, right?
As the name implies, you don’t have to reach a 100% utilisation just to get a bad score. Since credit utilisation takes up a huge portion of your credit score, many credit reporting agencies suggest that your expenditures should not even reach your limit by even within a thousand pounds, depending on the limit.
The 30% rule states that your spending should be, well, just within 30% of your available credit. If you have a credit limit of £2,000, your expenditures should not go beyond £600 every month. If that limit is at £3,000, then the spending should be at no more than £900 and so on and so forth.
But therein lies the problem. More than 18 million of the adult population in the UK are not aware of this rule. As such, a lot of credit holders use more than 50% of their available credit per month.
What even makes things worse is that 43% of that population miss out on their payments as well. So, aside from a derogatory remark on their credit utilisation, they also have multiple negative remarks on their payment history. The end result, obviously, are credit scores that could go as low as 300 or the Very Poor range.
The 30% Rule applies to each and every card you have. So this means that you should not go beyond 30% of your overdraft as well as the 30% of each of your credit cards if you want to have a good credit score.
The logic behind the rule is that you, as the credit holder, should give an impression to the lender that you are a sensible and responsible spender. More often than not, a lot of people get overwhelmed when they are given their credit card, spending way too much in a short period of time.
By following the 30% rule, you can show to lenders that you at the very least know when and how to use a credit card. If you can even maintain your spending below that threshold, like at 25%, then all the better.
But what if you have to go beyond 30% for that month? Some creditors might actually be lenient enough to give you a decent score despite going beyond 30%. For that, they would need to check on your credit history and see just for what exactly you had to use that card.
Payments for emergencies like non-insurable injuries and illnesses and repairs done on the home after an accident are acceptable for the agencies. Impulse buys like that 40 inch LED TV you saw at an online store is not.
Although having multiple credit cards might look like a good idea to keep your credit utilisation ratio within the 30% threshold, it won’t work in the long run. There are other factors at play when lenders look at your credit application.
First, aside from the percentage of debt you have in your card, lenders will also look at the total available credit you have before making a decision. So, if you have 10 credit cards, even with 3 of them with a balance, that would still mean that your total available credits are more than equal to your average monthly salary. Adding new lines of credit would be unnecessary which is why the lender would reject your application.
Another factor is the frequency of your applications for new credit. Aside from the fact that each new credit application would give rise to a hard search, which can affect your credit score, multiple credit applications done in a short period of time is a red flag for many lenders. For them, this shows that you are quite desperate for credit. If you have to apply for multiple credit cards, then at the very least schedule your applications so that there is a considerable amount of time in between each submission.
Lastly, there is the respective utilisation rate for each of the cards you have. If you have 10 cards and nearly all of them have 30% utilisation rates, your credit score won’t look good either. The general rule is that your credit utilisation for each card should decrease the more cards you have with an active status.
Fortunately for you, the 30% Rule applies only to transactions where there is a limit to the actual amount that you can borrow and use. Any transaction where the amount you can borrow and repay is set right from the start like a loan won’t be included here.
That being said, however, the way you treat your payments for these types of transactions will still affect your credit score. If you make your payments on time for your loans, then your score would improve. Miss out, on the other hand, and your credit score will drop like a lead balloon.
So how do you make sure that your credit utilisation rate actually helps your credit score, not hurt it? The most obvious answer will be to follow the 30% Rule which is to make sure that your utilisation rate within that limit.
But that’s easier said than done. To really make sure that your credit utilisation does not go beyond 30%, there are a few tips that you can follow.
Make it a habit to track your activities in each card you have especially on your spending. If you are close to reaching 30% of the limit for that card, make the payment or switch to using another card.
If you have a lot of necessary expenditures each month that would require you to go over the 30% mark, your next best option is to ask your lender to raise the limit of that card. A change of limit by even £1,000 can tremendously change your utilisation rate.
For instance, expenditures totalling £900 might be 45% on a card with a £2,000 limit but it’s just 30% on a £3,000 limit. If that limit is at £4,000, then the utilisation rate is at a mere 22.5%. And so on.
Of course, an application for a limit increase is similar to an application for a new credit which initiates a hard inquiry. But if you maintain good credit habits, your score can recover within a few months time. Also, this strategy works if only the limit is raised, not your spending also.
Now, if either strategy is a bit labour-intensive for you, the simplest solution you can take is to just pay for your charges more than once per month. By paying the amount you have charged on your credit, you effectively re-set the utilisation rate for that month back to a lower percentage. This means that you should be able to keep your utilisation rate at 30% even if you are technically going beyond the limit every month.
In addition, there is the fact that each payment you make will be reported to the credit agency. The more payments you make for your purchases, the better your overall credit score would be in the next report.
There are also other tricks that you can use to improve your credit score aside from lowering your monthly credit utilisation rate. Here are some of them:
1. Don’t Miss Out on Payments – This sounds simple enough but the way you treat your obligations tells lenders a lot about you. Keep your payments on time and this gives the impression to any future lender that you have what it takes to handle any debt you incur with them.
2. Keep Your Finances Separate – The thing about financial associations is that they can help or hurt you. If you’re the more creditworthy one, you will either bring your associate up or that associate’s poor credit score will bring you down. If possible, keep your financial associations down to a minimum. Don’t become a guarantor to somebody else if not necessary and don’t open a joint account with another person unless you’ve known them properly.
3. Don’t Move Too Much if Unnecessary – Unless your career requires you to move regularly, don’t make it a tradition of sorts within your household to change addresses on a regular basis. A constant change of address suggests that you are financially unstable to lenders. It might not damage your score but it does negatively affect your creditworthiness to potential lenders.
A credit score can be used for a number of instances, even ones that don’t necessarily revolve around money. One of these happens to be when you apply for new jobs. In fact, there are some sectors right now that require you to have a good credit score for you to get hired. These will include:
The reason here is quite obvious. Financial positions require you to have more than the basic understanding of how financing works. Also, you should have displayed a sense responsibility of sorts in managing your own money before a company hires you to handle somebody else’s.
Trustworthiness is something that officials are looking for in any person applying for a government job right now. An applicant must show that they are able to conduct their work following various complex systems and protocols as well as have the integrity to not be swayed into taking bribes. More often than not, one’s credit history can give the government an idea as to how trustworthy that person is.
Like in finance, applicants for accountancy-related jobs must show that they have a good sense of financial management as well as trustworthiness when it comes to handling the finances of others. A credit report, especially on the credit and payment history, will give employers that assurance that an applicant is right for the job.
Surprisingly enough, peak physical performance and mental aptitude are no longer enough when hiring for the British Armed Forces. This is not exactly mandatory for all military branches but there are instances when organisations like the Navy and the British Army would pull up credit reports when screening applicants.
This all goes back to the groups requiring people of integrity to serve the country. An inability to look after one’s own financial obligations tends to put that integrity in serious doubt.
When you run for office, it is best that you have all your finances in check. In fact, your credit score can be used against you especially if it is that poor. There are even countless examples of politicians out there who got their chances of winning an election ruined or their tenure in the position they won cut short because they failed to account for their past financial decisions.
This is not all true for all security services but credit checks are often initiated by some security companies for their applicants. For the same reason that other jobs have, these companies would want that applicant to be reliable enough in handling the valuables of others and have enough integrity to conduct their job without giving in to temptations which include, of course, bribes.
Airport security services are known for having the strictest job application processes out there. Some security companies even require your score to be at the 600-850 range if you want to have the best chances of getting hired.
It goes without saying that being armed with the right information can help a lot in preventing problems in your finances from popping up. Even if that number is something different, the 30% rule in credit utilisation rates is there to encourage you to spend within or below your means.
Simply put, it’s your needs that will determine how much you may use your card, not the limit set on that by the lender. Add to this other sound financial management decisions like paying your dues on time and you’d have a strategy to get your scores up and keep them within a favourable range.
Do you think the 30% rule is a bit too restrictive? What do you think are other ways that you can keep your utilisation rate at a low? Let us know in the comments section below.