Credit utilization ratio is one of the factors that can affect your credit score. Hence, it is important to understand what credit utilisation ratio is, how it works, and how you can manage it in such a way that it works for you.
Credit Utilisation is about how you’re using the revolving credit which is usually offered on credit cards. Hence, it’s more about how much revolving credit you’re using on all your credit cards. The more you spend on your credit card, the higher is your credit utilisation.
Now, the credit utilisation ratio, sometimes called credit utilisation rate, is the amount of credit you’re using to the total amount of available revolving credit. This means the total credit you owe on all your credit cards to the total credit limit available on all your credit cards. Credit utilisation ratio is typically expressed as a percent.
For instance, you have two credit cards, having a total limit of Rs.1 lakh, and an outstanding balance of Rs.50,000 on one card and Rs.0 on another card.
Then your credit utilisation ratio is calculated by dividing the total outstanding on both the card (Rs.50,000 + Rs.0) with the total credit limit on the cards (Rs.1 lakh).
Credit utilisation ratio on your card thus becomes (1,00,000 ÷ 50,000) × 100 = 50%
Your credit utilisation ratio is 50%, which means you’re using half of the total credit available for you.
Credit utilisation ratio can also be calculated for each of your credit cards and is called per-card ratio.
Different credit agencies may have a different cut-off to determine the ideal credit utilisation ratio. However, it is usually recommended to have a total credit utilisation ratio below or equal to 30%.
For instance, if your total credit limit on all your credit cards is Rs.1 lakh, your total outstanding on all the credit cards at any point of time should not exceed Rs.30,000.
Credit utilisation ratio is typically considered by the credit rating agencies like CIBIL and Experian to calculate the credit score.
The ratio can impact up to 30% of your credit score making it one among the most influential factors.
A low credit utilisation ratio indicates you’re depending less on credit. This makes credit agencies believe that you’re good at managing your credit and are spending within the limit. This, in turn, helps you secure a high credit score.
High credit score further enables you to secure other credit lines such as auto loans, home loans, personal loans, etc., much easier.
On the flip side, a high utilisation ratio could send a message to the potential creditor that you’re struggling to manage your finances. This would lead to less or no eligibility for a loan.
Now that you know the importance of having a low credit utilization ratio, you must be wondering how to achieve that. Below are a few financial habits that could help you score well.
When you surpass the 30% limit on one credit card, try to balance it with your other cards. Either not use them till you repay the outstanding or use the least amount possible so that the average utilization comes below 30%.
Follow the math every month on every credit card to achieve a low utilization ratio.
Remember, every month you clear your credit card dues, you’re affecting your credit utilization ratio. Repaying the entire debt or making substantial payments every month would significantly bring your ratio below 30%.
Even when you’re not making full payment, make sure to keep your outstanding dues as low as possible to achieve a low rate.
However, this isn’t possible if you overspend on the other credit card. Check your total available credit, calculate 25% to 30% of it, and accordingly plan your spends.
While having too many credit cards compared to your overall credit mix would negatively impact the score, too many credit score checks, especially by new creditors, in a short time can also have a bad influence on the score.
Hence, based on the existing credit cards you possess and their limits, carefully consider the right number of credit cards you should have based on your financial ability.
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