An Easy Guide to Credit Utilization Ratio
One of the main factors that impacts your credit score is your credit utilization ratio. If you are a credit cardholder, this blog is a must read!
What is Credit Utilization Ratio?
Credit utilization ratio, also referred to as credit utilization limit, simply refers to the amount of credit being used as compared to the available credit limit and is typically expressed as a percentage. If you have multiple credit cards, then the credit utilization ratio will be calculated based on the total credit limit available in all of your cards.
For eg. if your credit limit is Rs.20,000 and your existing balance in that card is Rs.10,000 then your credit utilization ratio is 50%.
Why is Credit Utilization Ratio Important?
Did you know that lenders use your credit utilization ratio as one of the key factors to determine your creditworthiness? Not only will this impact your eligibility to avail credit in the future, this criterion will also determine the amount of credit you can get.
If your credit utilization ratio is high, it could indicate that you are an over spender and will result in a lower credit score. And if lenders perceive you to be a risky borrower, then the chances of you availing credit in the future will be low.
Based on expert advice, an ideal credit utilization ratio is 30% of your revolving credit.
Note: Revolving credit is a facility for customers that allows them to borrow and use available funds as and when required.
How is Credit Utilization Ratio calculated?
Calculating your credit utilization limit is quite simple, as given below –
(Total Amount Outstanding on All Cards/Total Credit Limit) x 100
For eg. if you have two credit cards with a credit limit of Rs. 25,000 each and the overall balance is Rs. 10,000 then using the above formula, your credit utilization ratio is –
10,000/50,000 x 100 = 20%
How to Maintain a Good Credit Utilization Ratio
As mentioned above, having a decent credit utilization limit (below 30%) is essential for a healthy credit score and luckily this is quite easily achievable. Here are a few tried-and-tested tips to help you maintain a good credit utilization ratio –
Spend within the limit
This goes without saying but ensuring that you do not exceed the recommended credit utilization limit of 30% is necessary. A significant chunk of your credit score is determined by your credit utilization ratio which is why it is necessary to be careful with your spending.
Repay in full
This is a commonly recommended step for credit card users as repaying your credit balance in full is highly beneficial. Not only will this keep your spending under control, your credit score will also thank you for the same.
Plan your budget
Credit cards come with a number of advantages but spending without caution can result in a lot of debt. Carefully plan your budget each month and use your credit cards only when necessary. Remember, the amount spent will have to be repaid.
If you are having trouble planning and tracking your spends, our Personal Finance Manager app is designed to help you with this. Not only does this app make it easy for you to track your finances, you can also set a budget to help you stay financially aware.
Avail higher credit limit if possible
Having a higher credit limit will mean that you have more to spend and your credit utilization ratio can be increased relatively. One way to do this is by availing a new credit card or requesting your credit provider to increase your existing credit limit. However, this option must be chosen only if it is extremely important.
Having more cards may tempt you to spend unnecessarily which could lead to more debt. Therefore, opt for this only after careful planning.
Keep older credit cards open
Closing your credit cards even if you are not using them frequently can reduce your credit limit which is why closing your older credit card accounts is not recommended.
The importance of having a good credit score cannot be overstated and your credit utilization limit is an essential factor that determines this. If you use credit cards, ensure that your credit utilization ratio is always within the recommended range.
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