What is Credit Utilisation Ratio and How to Improve It

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.

Let’s begin.

What is the Credit Utilisation Ratio?

Credit utilisation is about how much of your available credit you’re using at any given time. It’s an important factor that credit rating agencies like CIBIL and Experian look at when calculating your credit score, making up about 30% of it.

When your credit utilisation ratio is low, it means you’re using only a small part of your available credit. This shows that you’re managing your money well and not relying too much on credit. A low ratio can help improve your credit score, which makes it easier to get loans for things like cars or homes.

On the flip side, a high credit utilisation ratio can raise a red flag for lenders. It suggests that you might be having trouble managing your finances since you’re using a large portion of your available credit. This can hurt your chances of getting approved for loans or other credit. Keeping your credit utilisation low is a simple way to maintain a good credit score.

How to Reduce Your Credit Utilisation Ratio

Now that you understand how important it is to keep a low credit utilisation ratio, you might be wondering how to make that happen. Here are some practical habits that can help you improve your credit score:

1. Stick to Your Limit: Just because your credit card has a high limit doesn’t mean you should spend up to that amount. Aim to keep your spending within 30% to 70% of your borrowing limit. If you find yourself exceeding 30% on one card, try balancing it out by limiting use on your other cards until you pay off the outstanding amount. Regularly check the math on your cards each month to maintain a low utilisation ratio.
2. Pay Off Your Balance: It’s important to pay off your entire balance each month. Regardless of how much you spend, clearing your credit card dues in full will positively impact your utilisation ratio. Each time you pay off your balance, you’re working to keep your ratio below 30%. If you can’t pay the full amount, aim to keep your outstanding balance as low as possible.
3. Don’t Max Out All Your Cards: To help lower your utilisation ratio, consider keeping some credit card accounts at zero balance. If you can, try not to use one or two of your cards for a few months. This approach increases your total available credit, which in turn lowers your utilisation rate. Just be careful not to overspend on your other cards during this time. Calculate what 25% to 30% of your total available credit is, and plan your spending accordingly.
4. Request a Borrowing Limit Increase: If you’ve had a credit card for more than six months and have been managing it well, you might want to ask your card issuer for a higher borrowing limit. If they approve it, your total available credit increases, which can help reduce your utilisation ratio, as long as you don’t increase your spending at the same time.
5. Consider Opening New Credit Cards: While applying for new credit cards can raise your overall borrowing limit, it comes with some risks. Opening a new account might temporarily lower your credit score. Also, having too many credit cards can negatively affect your score. If you decide to go this route, be mindful of how many accounts you already have and the limits on them to ensure it fits your financial situation.

How to Calculate Credit Utilisation Ratio

To find your credit utilisation ratio, you can use a simple formula:

Credit Utilisation Ratio = (Total Outstanding Amount / Total Available Credit) x 100

Consider the example where you own three credit cards, X, Y and Z with a total borrowing limit of Rs 2 lakh. Also, you have an outstanding balance of Rs 25,000 on X, Rs 60,000 on Y and Rs 3,000 on Z.

The total outstanding balance including all the three cards will amount to (Rs 25,000 + Rs 60,000 + Rs 3,000) i.e. Rs 88,000. Now, the credit utilisation ratio can be computed as (88,000 / 2,00,000) X 100 = 44%

Here, your credit utilisation ratio is 44%. You can also calculate the credit utilisation ratio for each credit card in the same manner.

How does credit utilisation affect credit score? (Existing keep it as it is)

A 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.

What is a good credit utilisation ratio?

A good credit utilization ratio is generally considered to be below 30%. This means that you should aim to use less than 30% of your available credit at any given time. For example, if your total borrowing limit across all your credit cards is $10,000, you should try to keep your total balance below $3,000.

Maintaining a low credit utilization ratio is important because it demonstrates to lenders that you are using credit responsibly and not overextending yourself. This can positively impact your credit score and improve your chances of being approved for loans and credit cards in the future

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:

1. 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.

2. 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 borrowing 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.

3. 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.

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Frequently Asked Questions (FAQs)

1. What is the ideal credit utilisation ratio I should maintain?

   It’s generally best to keep your credit utilisation ratio as low as possible to support a healthy credit score. A good target is to keep it below 30%.

2. Why is the credit card utilisation ratio important for my credit score?

   Keeping a low credit utilisation ratio is important because it accounts for about 30% of your overall credit score. The less you owe compared to your available credit, the better it is for your score. If you run high balances on your credit cards, it can raise your utilization ratio and hurt your credit score.

3. Is the credit utilisation ratio calculated for each credit account or all of them combined?

   Your credit utilisation ratio is based on the total amount of debt across all your revolving credit accounts and your total available borrowing limit.x

4. My credit utilisation is over 70%. Is that bad for my credit score?

   Yes, having a high credit utilisation ratio can negatively affect your credit score. It’s generally recommended to keep it under 30%. If that’s not achievable, try to keep it below 50% at the very least.

5. What happens if I exceed the borrowing limit on my credit card?

   If you spend more than your borrowing limit, you’ll likely face a penalty fee, as outlined in your credit card issuer’s terms and conditions.

6. How can I lower my credit utilisation ratio?

   The simplest way to lower your credit utilisation is by reducing your spending. This can help you keep your balances lower.

7. Is a lower credit utilisation ratio better?

   Yes, a lower credit utilisation ratio is beneficial for improving your credit scores. However, having some utilization is better than having none at all.