Credit Utilization Ratio is second on the list of factors affecting your credit score. It comes just after payment history. Your credit utilization ratio indicates how prudent you are with debt management.
Your credit utilization ratio is calculated based on all available credit to you and how much you have utilized. Maintaining a low credit utilization ratio is important to have a healthy credit score, but is it good to have a 0% Credit Utilization Ratio?
While having a low credit utilization ratio is good, not using your credit at all will not bode well with lenders. They want you to use your credit card but in a controlled way.
Experts suggest that a credit utilization ratio of 1 – 10% is good to achieve an excellent credit score.
What is the credit utilization ratio? How is it calculated?
Your Credit Utilization Rate, also known as your Credit Utilization Ratio, is the amount of revolving credit you're actually using divided by the total amount of revolving credit you have available. In other words, that is the amount of your current debt divided by your credit limit. It is commonly expressed as a percentage.
For example, if you have a credit limit of Rs.1 lakh and have utilized Rs. 10,000 out of it, your Credit Utilization Ratio will be
(10,000/1,00,000) * 100 = 10%
Remember, your credit utilization ratio is calculated on the total of all your available credit and not just one credit card. So, if the total available credit from all your credit cards equals Rs.5 lakhs and you have used only Rs. 10,000, the credit utilization ratio is only 2%, which is good for your credit score.
What is the impact of the credit utilisation ratio on my credit score?
When deriving your credit score, credit rating models often take your credit usage rate into account. Depending on the rating model used, it affects up to 30% of a credit score making it one of the most important factors.
If you have a low credit utilization score, it indicates that you are using less than what is available to you. This is usually viewed by credit rating models as an indicator that you're doing a decent job handling credit by not overspending, and keeping your spending in check will help you earn better credit scores. Higher credit scores will make it easier to get extra credit when you need it, such as home loans, car loans, and credit cards with better terms.
Additional Readings: Understanding Your Credit Utilization Rate and How to Improve It
Why a 0% credit utilization ratio is not good?
When your credit utilization ratio is 0%, it indicates to lenders and credit card issuers that you are not using your credit card. It's important to remember to use your credit. Although a 0% utilization rate is better than a high ratio, it isn't as good as anything in the single digits. Depending on the rating formula, some experts advise looking for a credit usage rate of 10% or less as a healthy target for improving the credit score.
Maintaining Zero Balance On Your Credit Card
There is a popular myth that you should always maintain a balance on your credit card to achieve a high credit score. This is not true and settling credit card bills in full and on time can help you improve your credit score significantly.
It is a healthy habit to clear off your entire outstanding every month. This will not only help you with your debt management but will also prevent any interest charges on your card.
So, the best bet is to limit your credit utilisation rate and pay off outstanding balances in full. Make sure that it is not more than 30% of your total credit limit. This way you are able to maintain a healthy credit utilization ratio and your credit score is also on the top.
What is a good credit utilization ratio?
It has been long believed that a 30% credit utilization ratio is good for your credit score. but in recent times, experts have been increasingly supporting a credit utilization ratio below 10%. They believe that a credit utilization ratio of less than 10% is good to achieve an excellent credit score.
How to maintain a low credit utilization rate?
It is important to lower your credit utilization rate without making it 0%. Here are a few simple tips to do that:
- Clear off any high outstanding amounts on your credit cards. You can go for a balance transfer so that you can pay them off quicker and cheaper.
- Maintain your credit card utilization below 30%. Do not make any high-value purchases that may affect your credit utilization ratio.
- Do not close any old credit cards. Make small purchases on them and maintain them. Closing them off will reduce your total available credit and thus decrease your credit utilization ratio.
The credit utilization ratio plays an important role in achieving a healthy credit score. While maintaining a low credit utilization ratio helps you, not using your credit at all is of no use. Have a good debt management strategy in place so that you don’t overuse your credit or end up defaulting on payments which will have adverse effects on your credit score.
- What is the best credit utilization ratio?
A credit utilization ratio of 1-10% is considered healthy to achieve an excellent credit score.
- Will it affect my credit utilization ratio if I have many credit cards?
Your credit utilization ratio is determined based on your spending against the total available credit limit. So, if you have more credit cards that would mean a high credit limit and lower credit utilization ratio. Hence, it is advisable to maintain all your credit cards in a controlled manner to achieve a high credit score.
- Should I pay off my credit card balance every month to achieve a good credit utilization ratio?
Paying off your credit card balance in full may not have much effect on your credit utilization ratio. Because your credit usage may be reported on any given day of the month. However, it is a good habit to pay off your credit card dues in full every month to avoid payment defaults and interest accruals.
- What balance is reported for credit utilization?
Generally, the balance on your credit card on the day of reporting is the balance counted against your credit utilization ratio.
- If my credit limit is Rs.3 lakhs, how much can I spend to have a good credit utilization ratio?
Experts suggest a credit utilization ratio of 10% and less. So, if your credit limit is Rs.3 lakhs, you can spend up to Rs. 30,000 every month to maintain a healthy credit utilization ratio.