Portrait Beauty Product Shop Manager Smiling To Camera. concept: Credit utilization
Betsy Wise
By: betsy_wise
Read in 8 minutes

Credit Utilization: Why Does It Matter When Applying For a Business Loan?

Take a short imaginary journey with me into the world of building sandcastles. First, you gather and utilize what you need: sand, and carving tools. You find out quickly that you can’t build with sand unless you wet it. Once you combine sand and water, the granules stick to each other so you can shape it into towers, walls, bridges, and arches. Sandcastle builders know that to succeed, they must literally pound the sand into submission.

Whatever you build, whether it’s sandcastles or your credit, you must follow the instructions to succeed. 

Therefore, this guideline will help you understand the importance of credit utilization when applying for a business loan and explain its relationship to your credit score and debt-to-income ratio. You’ll also discover how lenders use credit utilization trends to make lending decisions.

Sandcastle on the sea in summertime. Seashore on beautiful day. Sand on the beach and blue water. concept: Credit Utilization

What is credit utilization?

If you don’t use the right combination of sand and water, your sandcastle falls apart. Likewise, failing to keep tabs on your outstanding credit balances compared to your overall available credit causes your credit to crumble because you haven’t built a solid financial foundation.

In other words, if you owe $1,000 on your credit cards and have a $2,000 credit limit, your credit utilization ratio is 50%. In this example, your credit utilization is high because the industry standard is below 30%.

You can see the impact credit utilization has on your credit when you apply for a small business loan. Lenders consider how much credit you have available to decide whether they loan money to you and what terms you qualify for. Your credit utilization reveals to lenders how you manage money. Bad credit utilization could convince lenders to turn down your application.

Credit utilization and your credit score

I’m guessing, but do you have a growing urge to jump in your car and travel to the beach to build a sandcastle? I certainly hope that happens but right now there’s more to learn. Namely, what’s the relationship between credit utilization and your credit score.

Black credit card on dollar banknote. concept: Credit Utilization

Your credit score is important when you get a business loan and five main factors affect it:  your payment history, amounts owed (credit utilization), length of credit history, credit mix (types of credit you use), and new credit.

FICO weighs these factors by giving each one a percentage of the total score:

Payment history – 35%

Amounts owed – 30%

Length of credit history – 15%

Credit mix – 10%

New Credit – 10%

If your credit utilization is high (over 30% of your total available credit), then lenders will rightly assume that you may not be able to repay your debts.

Just so you know, the graph below by Fundera indicates that higher credit utilization lowers your credit score. 

Fundera, credit utilization

You improve your credit score by decreasing credit utilization. To do that don’t use over 30% of your available credit, know how much you charge on each card, pay off your credit cards each month, and monitor credit bureau reports. Only ask for increases on credit card limits when you complete the previous four steps to lower credit utilization.

Credit utilization and debt-to-income ratio

Lenders want to know how much of your monthly income goes toward paying your debt. By calculating your debt-to-income ratio as a percentage, they can determine your ability to repay a loan. A low ratio such as 10% means you only use 10% of your income to repay debt. Most lenders set a benchmark of 36% as a cutoff because borrowers at higher debt-to-income ratios (DTI) would have a harder time paying down a loan balance.

Not only are credit card payments used to figure your debt-to-income ratio, but mortgage payments, auto and student loans, child support and alimony payments, and other loan payments are all considered financial obligations. If your monthly debts total $1,500 and your monthly income is $3,000 your debt-to-income ratio is 50%.

When credit utilization and debt-to-income ratios are both high, you probably won’t qualify for a loan. Some DTI ratios may be acceptable with one lender but not with another, as many lenders set up their own DTI ratios. They use DTI as a measuring stick for credit along with credit reports and credit scores.

If you have too much debt, pay down credit card debts and loans and don’t take on new debt. You could get a debt consolidation loan, increase your income and slash business expenses when possible. Unlike credit utilization which does affect your credit score, DTI won’t because income isn’t reported to credit bureaus.

3D illustration of a conceptual gauge with needle pointing to very bad scoring. Business credit score concept. concept: Credit Utilization

Credit utilization trends

Okay, I get it. By now, you want to know who built the tallest sandcastle. In 2017, Schauinsland-Reisen GmbH, a German travel agency, built a 54 foot, 9-inch sandcastle in 25 days using 3,500 tons of sand. 

Lenders are just as curious to review trended credit data as you are about sandcastle trivia. They want to know whether you pay off credit card bills on time or carry balances each month as debt.

Lenders don’t want to see that you habitually make minimum payments causing your balances to grow. Likewise, by reviewing credit data they can determine a borrower’s spending patterns and credit usage over time to understand how you manage your finances.

Experience the Camino Financial difference

At Camino Financial, we approve loans even if applicants have unfavorable credit utilization. However, good credit utilization does enable borrowers to receive better interest rates.

Because we believe in our motto, “No Business Left Behind”, we tailor our microloans and small business loans to meet your business’s financial needs. When you apply for a loan, a loan specialist thoroughly goes over your funding options and our requirements. Camino Financial loans are convenient, quick and have fewer restrictions as compared to other lenders.

As you may have noticed, credit cards are important to credit utilization. So, in addition to this article about credit utilization (and sandcastles), we recommend reading:

two hands holding a business credit card

Do’s and Don’ts When Using a Business Credit Card

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