Credit Card Utilization: What You Need to Know

Thinking about applying for a small business loan? You might want to curb that credit card spending first.

Although lenders won’t typically ask to see your personal credit card statements, they will closely scrutinize your credit report. To this end, your personal credit card debt affects your personal credit or FICO score, and your credit card balance will show up on your credit report. This gives loan underwriters a glimpse into how much you spend. They can also match information on your credit report with your bank statements in order to see just how much you’re paying off—and how much credit card debt you’re carrying at the time you apply for the loan.

So what do you need to know in order to better manage your credit card spending and pave the way to getting that small business loan? Read on to learn how to get a handle on your credit card debt.

Personal Credit Card Debt Can Affect Your FICO Score

Your business track record and revenue might top the list of what lenders will ask for when you apply for a loan, but they’ll still want to see your FICO Score—which reflects your personal credit and debt.

Because many small businesses get formed as sole proprietorships, especially when they’re just starting out, it can be easy to put those business expenses on your existing credit cards. You also might not have stellar credit, which can make it difficult to get a dedicated business credit card. So using personal credit cards for both personal spending and business expenses can be an easy trap to fall into.

But using your personal credit cards will lead to intertwined personal and business spending and can result in high monthly balances on your credit cards. If you don’t pay off the minimum balances or if you spend the bulk of your available credit, you risk lowering your credit score—which doesn’t look very good at all to lenders. Simply put: the higher your FICO  score, the better off you are when it comes to qualifying for a loan.

Let’s take a bit of a deeper look. Here are some ways your FICO score can impact the loan qualification process:

• If you’re a new small businesses owner, you probably don’t have any proven history or revenue stream. This makes your credit score even more important when it comes to getting a loan. At a traditional bank, for example, a loan will be hard to come by if you’re in this situation—unless your credit score is about 700 or higher.
• Without a high credit score, you can still get a loan at many non-traditional lenders. That said, you’ll likely pay higher interest rates. “Our loan consultants spend a lot of time advising loan applicants on credit scores,” says Joanna Ray, a senior underwriter at Accion East, a lender who focuses on small business owners in underserved communities. Accion East will underwrite loans to those with FICO scores as low as 575, says Ray.

Keep A Watchful Eye on Your Credit Card Utilization

What exactly is credit card utilization? In a nutshell, it’s the amount of available credit you use every month. This is also sometimes referred to as your ratio, which is your open credit card balance divided by your available credit card limit. The resulting percentage is a key figure that gets factored into your FICO score.

Typically, the higher your utilization, the lower your credit score—so this number can label you as a lending risk. For example, if you routinely charge an excessive amount to your credit cards each month, reaching your credit limit or even exceeding it, you’ll negatively impact your credit score and probably hurt your chances at getting a loan.

Tips to Improve Your Utilization

Most lenders will tell you that you shouldn’t max out your credit cards if you want to get a small business loan. In fact, try to make sure your utilization rate is about 50% or lower. But if you routinely spend more than 50-70% of your available credit line, here are some tips to lower that rate and improve your chances of loan approval.

• Try to curb your spending and create a budget so that you don’t max out your credit cards.
• If you have more than one credit card and use one of them the most often, start spreading your charges around while keeping more than 50% of your available balance open on all of your cards. This way you’re less likely to run up spending on the card you typically use.
• Call your credit card company and ask if it’s possible to extend your line of credit. If so, you can do this while cutting back on your spending. That will give you more available credit—and improve your utilization rate.
• Open another credit card if you can, and either don’t use it or leave a high available limit on it at all times.

“Having credit cards open without a lot of debt on them is a benefit if you want to get a loan,” says Ray.

Ray also recommends earmarking a little bit extra each month to paying off existing credit cards. Having more of your available credit line open will not only leave you with a cushion and improve your utilization rate—it’ll also show lenders that you can afford your household and business expenses.

Maxing out your credit limit every month to pay for car payments and household expenses—on top of business expenses—indicates that you could be living beyond your means. This is a red flag when it comes to getting a loan that you’ll want to avoid.

Be Careful About Too Much Debt on Your Business Credit Card

Lenders say it’s a smart move to get a business credit card if you have good enough credit to qualify. Not only can you keep your personal and business expenses separate, but a business credit card—used properly—will help free up your cash flow.

But even if you have a business credit card, you might still want a loan. If so, it’s important to understand that when you apply for a loan, a lender will likely ask for a business debt schedule and, along with any other debt, your business credit card debt will have to get a detailed overview.

“Lenders more or less look at business credit card debt like any other type of debt,” says Ryan Conti, an account executive at Fundera.

Loan officers routinely look at whether you’re able to make your minimum monthly payments with available funds left over after paying other bills and expenses. It’s important to show that you can pay off your minimum balance with enough free cash flow left to make loan payments, according to Conti.

“When we look at your free cash flow in your business, we make sure you can meet your payment obligations,” he says.