The credit utilisation ratio is one of the important factors that is considered while calculating your credit score. And yet not many people know what it really means.
Let’s delve deep into the know-how, know-what and know-why of a credit utilisation ratio. In this article, you’ll find answers to some of the most common questions about credit utilisation ratio.
What is credit utilisation ratio?
The credit utilisation ratio is the ratio of your total credit card balances and your total credit limit.
For example, if you own two credit cards with a credit limit of ₹ 1 Lakh each; then, your total credit limit becomes ₹ 2 Lakh. Say you have an outstanding balance of ₹ 0 on one card and ₹ 25,000 on the other, you then have a total outstanding balance of ₹ 25,000. Your credit utilisation ratio, in this case, is 12.5%. That means you are using only 12.5% of your total available credit.
Here’s the big takeaway here…
The lower your credit utilisation ratio, the better it is for your credit scores.
But there’s more to credit utilisation than just that. In other words? Keep reading!
How to calculate credit utilisation ratio?
- Add up your credit limit on all your credit cards.
- Add up your current outstanding balance on all these credit cards.
- Then, divide the total outstanding balance by your total credit limit.
- Next, multiply it by 100 to get the percentage.
Here’s the formula
Credit Utilisation Ratio= Total Credit Balance ÷ Total Credit Limit x100
An example to sink it in:
|CREDIT CARDS||OUTSTANDING BALANCE||CREDIT LIMIT|
|Credit Card A||₹ 2,00,000||₹ 4,00,000|
|Credit Card B||₹ 30,000||₹ 2,00,000|
|Total||₹ 2,30,000||₹ 6,00,000|
So, 2,30,000 ÷ 6,00,000= 0.38 x 100 = 38%
In this case, the credit card utilisation ratio is 38%, which isn’t great but it’s not terrible either. Your goal should be to keep the percentage as low as possible.
Lenders also take into account your per card utilisation rate. Consider the example above. Credit Card A has a credit utilisation ratio of 50%! That’s a red flag for lenders, even if your credit utilisation ratio is low.
How does credit utilisation affect credit score?
High credit utilisation 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 utilisation ratio, lenders assume you are a good borrower looking at your spending behaviour, which is under control.
However, if you do exceptionally well in other areas of your credit report, with a clean record of on-time payments and no defaults, your credit utilisation ratio may have less impact on your credit scores.
But if your credit file is thin, with just a credit card opened recently, your credit utilisation ratio may significantly impact your credit scores.
A key takeaway here…
If you want to achieve high credit scores, work towards lowering your credit utilisation percentage as much as possible.
What is a good credit utilisation ratio?
The lower the credit utilisation ratio, the better it is for the credit scores. Experts say that you should keep your credit utilisation ratio below 30%.
It sounds like a no-brainer, but to achieve below 30% credit utilisation is not an easy task. Below are tips you can use to keep the percentage low:
3 Ways to Improve Your Credit Utilisation Ratio
Paying off as much credit card debt as you can is the first and most obvious way to keep your credit utilisation ratio low. But there are other ways too. Let’s have a look:
- Make Multiple Payments Every Month
Credit card lenders report your balances to the credit bureaus once every month. If you pay your bill in full, but if your lender submits the report to the credit bureau before the end of the billing cycle, it may appear that you have a large amount as balance on your card. To avoid this situation, make multiple small payments instead of one large payment each cycle.
- Don’t Close Your Credit Cards
It may seem obvious to close the credit card if you are not using it. But, don’t. Keeping the credit card open will increase your credit limit and lower your credit utilisation. That said, don’t be tempted to use the credit card. If that’s what you are worried about then just cut it up.
- Get a Personal Loan
Another way to reduce your credit utilisation ratio is by paying off the credit card debt with a personal loan taken at an interest rate lower than that of the credit cards. However, you need to be cautious with this route. Taking on more debt to pay off your other debt can only be successful if you have solid financial discipline. Otherwise, you’ll be caught in the vicious cycle of debt with fewer chances of being debt-free.
Above all, pay your bills on time, every time.
If you are in need of a personal loan, MoneyTap offers instant loans at a competitive interest rate. Get MoneyTap now!