The credit utilization ratio is probably one of the least understood terms even though it has a significant impact on your credit score. Today we will delve deep and try and understand everything about credit utilization ratio.
What is the credit utilization ratio, and how is it calculated?
The credit utilization ratio is straightforward to calculate as it is the ratio of total credit card balances vis your total credit limit. Let us explain with an example. If you have two credit cards each with a credit limit of ₹ 2 Lakh each; then, the total available credit limit becomes ₹ 4Lakh (2 lakh and 2 lakh). Now let us assume that you have an outstanding balance of ₹ 50000 on one card and ₹ 0 on the other, this would mean that your total outstanding balance would be ₹ 50,000. The ratio of both would be 12.5% this indicates that you are using12.5% of your the total available credit.
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But there is a catch about which very few people are aware of: the lower your credit utilization ratio is, the healthier your credit score will be.
How to calculate your credit utilization ratio?
- Gather all your credit cards.
- Now, add up the credit limit of all your credit cards.
- Next, add up your current outstanding balance on all the credit cards.
- Divide the total outstanding balance with your total credit limit.
- Now, multiply this number by 100 to get the percentage.
The formula to calculate the credit utilization ratio is:
Credit Utilisation Ratio = The Total Credit Balance ÷ The Total Credit Limit x100
Let us take a look at another example to sink it in:
CREDIT CARDS OUTSTANDING BALANCE CREDIT LIMIT
Credit Card A ₹ 3,20,000 ₹ 4,00,000
Credit Card B ₹ 30,000 ₹ 3,00,000
Total ₹ 3,50,000 ₹ 7,00,000
So, 3,50,000 ÷ 7,00,000= 0.5 x 100 = 50%
Here, the credit card utilization ratio came to be 50%, which isn’t excellent, but it’s not disturbing either. Ideally, the credit card utilization ratio should be kept as low as possible.
Lenders and credit card issuers also take into account your per-card utilization rate. Bad credit utilization is a red flag for lenders, as it means that you are not able to manage your finances well.
Does credit utilization impact the credit score?
High credit utilization ratio means lenders assume that you are bad at managing finance, and you definitely cannot afford your lifestyle. So, your profile becomes risky.
But if you have a low credit utilization ratio, lenders assume you are a good borrower looking at your spending behavior, which is under control.
However, if you have a clean record of on-time payments and no defaults, then your credit utilization ratio may have less influence on your credit scores.
But if your credit file is new, with just a recently opened credit card, your credit utilization ratio may significantly affect your credit scores.
So …
If you want to attain high credit scores, then work towards reducing your credit utilization percentage.
What is deemed a good credit utilization ratio?
The lower the credit utilization ratio, the more beneficial it is for the credit scores. Specialists say that you should keep your credit utilization ratio under 30%.
You might be thinking that it is challenging to keep this ratio below 30%. Yes, keeping credit utilization is not an effortless task, but here are some tips of how you can do it.
Ways to Enhance Your Credit Utilisation Ratio
Paying off your credit card debt as much as you can is the first and most natural way to keep your credit utilization ratio low. However, there are other ways too. Let us have a look:
Don’t Close Your Credit Cards
Although, it may seem apparent to close all the credit card in case you are not using it. However, we advise you against it; especially it does not have any annual charges. Keeping the credit card available for use will only increase your credit limit and lower your credit utilization.
Make Multiple Payments to your card Every Month
Credit card issuers report your balances once every month. So, if you choose to pay your bill in full, your lender may indicate a large amount as balance on your card. You can avoid this situation by making multiple small payments instead of one large payment each cycle.