Credit utilization is one of the biggest factors affecting your credit score. Learn more. 

Your credit utilization ratio refers to the amount of your credit card balance compared to the credit limit. It plays a major role in your credit score. If you use less than 30% of the total credit available, you will have a good credit utilization ratio.

Having a healthy credit utilization ratio is important if you want to build and maintain a healthy credit rating. If your credit utilization increases, conversely, your credit score can decrease. A high credit utilization indicates that you are credit “hungry”. Lenders view you as a risky candidate if your credit utilization ratio is high, as it indicates that spending a lot of your monthly income on debt payments. This puts you at a higher risk of defaulting on your payments.

A high credit utilization could lead to your credit card and loan applications being rejected by lenders. This will further hurt your credit score. If, on the other hand, you are approved for the loan/credit card, you may have to pay higher interest rates or make a larger down payment than if you had a good credit utilization. A good credit utilization ratio helps you bargain with your lenders for a good rate. So, what is good credit utilization? Read on to know more! 

Ideally, the best credit utilization is zero percent, which would mean you are not using any of your available credit. However, this is not possible. If you don’t use your credit cards, chances are, your credit report won't reflect a zero balance, as having a credit card comes with its fair share of annual fees, renewal fees, etc. Having said that, a good credit utilization ratio is less than 30 per cent. That means you must use less than 30 per cent of the total credit available to you. For instance, if you have a credit card with Rs. 1 lakh of credit limit, you must keep your balance below Rs. 30,000. As your credit card balances rise above that threshold, chances are, your credit score could drop considerably. 

How to calculate credit utilization? 

Your credit utilization is a simple ratio that you can easily calculate. You will need information regarding all of your credit card limits and credit card balances. You can get this information by checking your most recent credit card statement. You can also call the toll-free customer service phone number of your credit card provider and speak to a customer care representative for this information.

Coming to the simple math calculations. Credit utilization is calculated by dividing a credit card's balance by the credit limit. The result will be a decimal. Multiply that number by 100 to get a percentage. This results in your credit utilization expressed as a percentage. If your credit utilization is high, it is time to lower your credit utilization ratio. Read on to know how to lower your utilization. 

How to lower your credit utilization? 

Credit utilization is a fluid number that changes its course as a river would. As your spending habits would differ month by month, and avail new credit cards, you will get new credit card balances and credit limits change. That said, you can lower your high credit utilization through a series of steps. This will reflect on your credit report and your credit score. There are generally two ways you can improve your credit utilization scenario:

1. Reduce your credit card balances. This can be done by paying off your credit card debt as much as you can. This will lower your balance and cause your credit utilization to drop quickly. However, this change may take some time to reflect on your credit report, as your credit card issuer may not report your balance until the end of your billing cycle. Ensure you keep your balance low so that it shows up on your credit report.

2. If you find that you can't pay down your balance right away, it is best to keep away from your credit card and use your debit card as much as you can. Refrain from new credit card purchases until you are able to make a large payment towards your credit card balance and reduce your balance as much as you can. Your balance will go down slowly over time and this will lower your credit utilization as well. 

3. Another way to lower your credit utilization is to apply for an increase in your credit card limit. You can contact your credit card issuer’s customer care to see if you qualify for an increase in your credit card limit. Keep in mind that this may not be easy as being approved for a credit limit increase very much depends on your income, credit history, and how much time has elapsed since your last credit limit increase (if you have applied in the past.)

4. Yet another way to lower your credit utilization is to apply for a new credit card. Opening a new credit card lowers your overall credit utilization. This would work if you leave most of the credit available on the new card. Again, getting approved for a new credit card will depend on your current income and your credit history. If you are rejected, it will only lower your credit score by a few points, so be sure before you apply.  

The credit utilization ratio is a key factor when it comes to determining your credit score, so it’s crucial to understand how it works. The higher your credit card balance in relation to your credit limit, the lower your credit score will be. As mentioned before, your combined credit card balances should be within 30 percent of your combined credit limits—this helps maintain a good credit score. Spending more than 30 percent of your credit limit is a risky move—even if you plan to pay off the balance when your billing statement arrives. This is because card issuers generally report the balance when your statement closes. Keep tabs on your credit card statements and pay enough to reduce your balances to less than 30 per cent just before the billing month closes. After all, a great credit score will only qualify you for larger loan amounts and attractive interest rates, while a low credit score can make your financial goals seem far away. 

Always practice healthy credit habits. After all, credit healthy toh credit wealthy! 

Additional reading:Your Credit Utilization Rate and How to Improve It