There are many factors that affect the credit score of an individual, but the most important among them is the credit utilization ratio. While many of us might have a fair understanding of this concept, few of us still remain untouched by this topic. We are not aware that what credit utilization ratio means and what impact it has on an individual’s credit score. The credit utilization ratio could have a great impact on your credit score and any change in this ratio could have an impact on your borrowing power as well.
Credit Utilization Ratio – Meaning
The credit utilization ratio is the ratio between the balance on all your credit cards and your total credit limit across all your cards. By studying this ratio, the lenders gain knowledge on how much are you using from your total available credit limit. The more you spend through your credit cards, the higher will be the credit utilization ratio. Credit utilization is calculated in the form of a percentage. Generally, a credit utilization ratio equal to or below 30% is considered a good ratio. Now, if you have a total credit limit of Rs. 2 Lakhs, the total outstanding on your credit card bills should not exceed Rs.60,000 (i.e., 30%).
Your credit utilization ratio is considered by the credit rating agencies such as CIBIL to calculate your credit score. This ratio holds a 30% share in calculating your credit score. If this ratio is above 30%, it will have a negative impact on your credit score. But if this ratio is kept below 30%, it will portray a positive image of yours in the minds of the lenders and hence will further help you in availing of various kinds of credits such as a new credit card or any type of loan like a home loan, personal loan, etc.
How does the Credit Utilization Ratio affect your credit score
Calculation of credit score depends on 5 factors.
– Payment History – This accounts for 35% of your credit score
– Credit Utilization Ratio – 30% of your credit score is based on this ratio
– Length of Credit History – 15%
– Types of Credit – 10%
– New Credit – 10%
From this ratio distribution, it is very much clear that the credit utilization ratio plays a major role in deciding your credit score. It is the second most important contributing factor to your credit score.
Now, a high utilization ratio or rate indicates that you have borrowed much from the market and hence you might be having difficulty paying off your loans. The lender gets an indication of risk after having a look at the high credit utilization ratio. This in turn affects your credit score in a negative way and prohibits the lenders to extend any further credit to you. Therefore for a better credit score and increased credit opportunities, you should try to keep your credit utilization ratio as low as possible. On the other hand, your credit utilization ratio starts improving as soon as you start repaying your debts. The more you repay, the better the ratio will be.
Suggested Read: Your Complete Guide To Credit Score
How to calculate credit utilization ratio
While the credit utilization ratio plays an important role while determining an individual’s credit score, hence every person should have knowledge about the calculation of the credit utilization ratio. For the calculation of the credit utilization ratio –
– Sum up the credit limits across all your credit cards
– Now total out the balances of all your credit cards
– Then divide the total balances by the total credit limit and multiply by 100
By doing this, you will get the percentage that will show the total percentage of credit that you have utilized through using all your credit cards.
Total Balance x 100
Total Credit Limit
Ways to reduce Credit Utilization Ratio
You need to have a low credit utilization ratio to avail further benefits such as enhanced credit limits, credit cards with better reward points, cashback deals, etc. The following steps can be undertaken to keep your credit utilization low –
- Pay in full – Make sure that you repay the entire amount that you have spent through your credit card every month. Lingering the balances will just attract charges and interest towards them. With added charges and penalties, the outstanding amount will keep on increasing, hence affecting your credit utilization ratio. Therefore, try to pay the maximum you can towards your debt and keep your balances as low as possible.
- Spend within the limit – You should always follow the rule of using your credit limit below 30% only. Having a credit card with a good credit limit does not mean that you have to use the whole of that limit. You always have to keep in mind that you have to utilize only 30% of that limit and you have to manage your expenses accordingly. Now if you have bypassed the ratio of 30% on a credit card, you will have to avoid using your other credit cards till the time you repay the existing debts or you will have to pay the least possible amount to bring down the ratio to below 30%.
- Credit Limit Enhancement – If you have a good CIBIL Score, you can get your credit limit enhanced by placing a request with your respective banks. After approval, when your credit limit increases, this will help you in getting a low credit utilization ratio based on the condition that you do not increase your spends after getting a credit card with higher credit limits.
- Avoid using all credit cards at once – You should avoid using your all credit cards together to achieve a low credit utilization ratio. You can keep a few of your credit cards unused for a few months if that is possible. By not using these credit cards for a few months, and paying bills regularly for the cards that you have already used, your available credit limit will start increasing and hence result in a low credit utilization ratio.
The credit Utilization ratio – which depicts the total credit limit that you have used using your credit cards, plays a very influential role in determining an individual’s credit score. Maintaining a low ratio is important to have a good credit score. Though it is prescribed to keep your utilization ratio below 30%, having a little over it will not be a huge deal. Keeping the credit ratio as low as possible will help you in achieving a good credit score and will further help you in availing credit cards with enhanced features and will open the door for other various credit