Credit Utilization Ratio

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.

What is Credit Utilization Ratio?

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.

How to Calculate Credit Utilization Ratio?

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.

What is a Good Credit Utilization Rate?

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.

How Does Credit Utilization Work?

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.

How to Reduce Your Credit Utilization Ratio?

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.

1. Spend within the limit: Just because your credit card has a higher credit card limit, you don’t have to use it to the fullest. Remember the 30-70 rule and try to limit your expenses to that extent.

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.

2. Re-pay in full: No matter how much you spend on your credit card, make sure to repay the entire outstanding balance in full every month.

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.

3. Don’t use all the credit cards: Another simple way to achieve a low utilisation ratio is to keep some credit card accounts with zero balance. This means don’t use one or two of your cards in a few months, if possible. This will automatically increase your total available credit limit, thus cuts down your utilisation 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.

4. Increase credit limit: If you have a good standing credit card account for more than 6 months, you can raise a credit limit increase request with the card issuer. If approved, it increases your total available credit thus helps you to get a low usage rate, provided you don’t increase your spends.
5. Apply for new credit cards: The option comes with a caution. Opening a new credit card account to increase your total credit limit might have a short-term negative effect on your credit score.

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.

Check your credit score now and know about your credit utilization ratio for FREE. A detailed credit report will be sent to your registered e-mail ID to provide you with a better picture of your credit utilization and score.