You must have heard the terms "Credit Limit" and "Credit Utilisation" in the context of credit cards. Have you been wondering what these terms are and how they really matter to a common credit card user? You must also must have heard that your credit utilization should not exceed 30 or 40%? Is it something to signify the number of times you should use your credit card?
We understand that there might be numerous doubts running in your minds regarding these terms and how exactly you can lower your credit card utilization.
Let us start with the basic terms: Credit Limit and Credit Utilisation Ratio
Credit Limit is the maximum limit set for utilization or spending on a credit card. It depends upon the income and other factors like credit score of the applicant.
Credit Utilisation Ratio: Credit Utilisation Ratio is the proportion/ratio of spend on your credit card to the overall credit limit of your card.
Why is Credit Utilisation Ratio Important?
Your credit utilization ratio is one of the important determinants of your credit score. It is important because it demonstrates how well do you utilize your credit card. Though you are given an upper limit of spend on your credit card, it is not prudent to spend the entire amount in a month. You may well be capable of paying the outstanding bill to the full each month, yet a high credit utilization ratio is construed to be a credit hungry behavior.
The ideal credit utilization of an individual is pegged at 30-40% of their credit limit.
How Do You Calculate Your Credit Utilisation Ratio?
Suppose you have a credit card with a credit limit of Rs 2,00,000 and you spend Rs 50,000 during a billing cycle. So, for that particular billing cycle, your credit utilization ratio will be Rs 50000/Rs 200000 which is 25%.
Since it is one of the important determinants of your credit score, a low credit utilization is helpful in raising your credit score.
Let us see smart ways in which you can lower your credit card utilization ratio
Draw up a budget
A budget forms one of the cornerstones of any financial planning. Whether you are planning to buy a house or it's your day-to-day running of your household, drawing a budget helps you immensely.
You may want to pull out some of your earlier credit card statements and check your expenditures. Once you know what is that you are mainly spending on, it is easy to cut down the discretionary or frivolous expenses.
If you realize that you are making a lot of payments through your credit card, then you may want to split it between credit and debit cards. These days there are lot of apps like Simpl and LazyPay that allow you to pay later. If you can use these apps judiciously, you can avoid/postpone some expenses incurred on your credit card.
After drawing up a budget, it is very essential that you follow it to the core so that you can reduce your expenditure on your credit card.
Pay Off a Bit Before the End of the Billing Cycle
Your credit card issuer reports your credit utilization ratio to the credit bureau generally at the end of your billing cycle. Though you are allowed a period of 15 days to pay your outstanding bill, make efforts to make the payment before even the credit card bill or the outstanding statement is generated.
For Ex: Your credit limit is Rs 1 lakh on your credit card. During a particular billing cycle, you incur an expense of Rs 70000 on your card. Suppose your billing cycle ends on the 20th of the month, try to make a payment of Rs 30000-Rs 40000 on your card before the billing date so that as on the date of billing, you end up having a good credit utilization ratio.
Though the purpose of paying by a credit card is defeated a bit, you can use this method to provide you some relief.
Consider For An Increase In Credit Limit
As credit utilization ratio is a function of your spending and the credit limit, the ratio comes down either with reduced spending or with increased credit limit.
If you use a credit card which was issued quite some time back when your income was low or it was a student credit card which was converted into a normal credit card, it may be time for you to increase your credit limit. The earlier credit limit would have been set in relation to your earlier income, but now, your expenses might have increased
Even if it is not an old credit card, you can still request your credit card issuer for a credit card limit increase. They might be happy to oblige you if you have been a prompt payer of your bills and have been responsible with your card usage.
However, a word of caution here would be to take care and not increase your spending along with the increased credit limit. Or all the efforts of increasing the credit limit would go for a toss.
If Possible, Get A New Card
You could also consider going in for an additional credit card. Going in for another card will increase your credit limit.
When it comes to calculation of credit utilization ratio, the combined spend on all your cards is calculated against combined credit limit on your cards. This way if you can keep your expenses at the existing level, then against an augmented credit limit, your credit utilization will come down.
Time Your Credit Card Spend
If you possess more than one credit card, then this simple trick may help you.
As we have understood that your credit utilization ratio is dependent on the balances reported to the bureau at the end of your billing cycle. So, if you have more than one cards, you can time your purchases so that the expenses are evenly distributed.
An added advantage of this will be that you would end up getting a longer credit period.
Do Not Close Unused Cards
You might have credit cards on which the terms are not favorable anymore. Or you end up getting a better deal on another card, then you might switch your spending to that card.
In this scenario, as you are not using the former card anymore, you may want to close as you do not intend to use it in future. However, we would advise you not to do so. If you retain your old card, the credit limit on that card will also get included against your overall credit limit, thereby giving you an increased credit limit.
Credit utilization is one of the determinants of your credit score. Remember there are also others that count. Being prompt in your repayments and borrowing only that you can afford to pay back remain the bottom-line for a good credit score.