Credit Utilization Ratio – Ideal Percentage

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What is the Credit Utilization Ratio?

Credit cards have revolutionized how people spend, especially in the 21st century. It is one of the best ways to borrow funds from the bank against a line of credit. However, you need to really understand how credit card usage can affect credit scores and the credit utilization ratio.

Credit Utilization Ratio refers to the percentage of credit that is being utilized from the borrower’s total available credit. This credit utilization ratio, as it is called, is one of the most critical factors that will impact your credit score. Most of the credit bureaus take into account your Credit Utilization Ratio before arriving at your final credit score. A high Credit Utilization Ratio leads to a low credit score.

Factors Contributing to Your Credit Utilization Ratio

The credit bureaus calculate Your Credit Utilization Ratio based on various factors. The following are some of the factors that contribute to your credit utilization ratio. They are:

• Credit Limit: The maximum amount that you can spend on your credit card determines your credit utilization ratio.
• Outstanding Balance: The outstanding balance amount available on your credit card determines your credit utilization ratio.
• Total Available Credit: If you have multiple credit cards, credit utilization is the net result of all of them.

How is the Credit Utilization Ratio Measured?

Credit Utilization Ratio is calculated using the formula given below:

Credit Utilization Ratio = (Total Outstanding Amount/Total Available Credit) X 100

This can be explained very well with an example.

Say, suppose you have three credit cards with a total credit limit of 5,00,000. You have spent Rs. 20,000 on Card 1, Rs. 30,000 on Card 2, and Rs. 40,000 on Card 3. Your total credit usage is around Rs. 90,000.

So, Your Credit Utilization Ratio = (90,000/5,00,000) X 100 = 18%

So, Your Credit Utilization Ratio is 18% which is very well within the permissible limits.

What is a Good Credit Utilization Ratio?

Keeping your credit utilization ratio well within the permissible limits will do more good than harm. This is an indicator that the borrower can handle their credit responsibly.

On the contrary, a higher credit utilization ratio indicates that the borrower is having trouble managing their credit or is overly dependent on it. This way, the lender might lose interest in them, as they might not be able to handle one more credit.

According to most of the credit bureaus, using less than 30% of your credit limit is considered an ideal credit utilization ratio.

Common Errors That Increase Your Credit Utilization Ratio

The following are common errors that may lead to a higher credit utilization ratio.

• Maxing Your Credit Cards: Please avoid using your credit card to the maximum limit, as it will raise your credit utilization ratio.
• Carrying Forward High Balances Month on Month: Failing to pay your outstanding credit card bills will leave your credit card utilization high.
• Making Only the Minimum Payment: Making the minimum payment keeps your credit card balances high. This will increase your credit utilization.
• Not Keeping a Track of Credit Card Spending: Maintaining a record of your credit card spending will help you monitor your spending.

Strategies for Maintaining an Ideal Credit Utilization Ratio

Maintaining an ideal credit utilization ratio over time can be challenging. But you can adopt specific strategies to manage a perfect credit utilization ratio. The following methods can be adopted to achieve an ideal credit utilization ratio. They are:

• Interrelation Between CUR and Credit Score:

Your CUR contributes to computing your credit score. Credit bureaus in India assign you a credit score between 300 and 900. Having a credit score above 800 will earn you premium credit cards and loans. Keeping your credit utilization below 30% can help you easily reach an 800 score.

• Track Your Credit Usage Regularly:

Regular checking your credit score helps you to maintain an ideal credit utilization ratio. Any increase in credit utilization might hurt your credit score. Try to keep a close eye on all payments made with your credit cards.

• Request A Credit Limit Increase:

If you have made on-time payments of your credit card bills, you can request your lender to give you a credit limit increase. Lenders might be more than willing to do so, as you have depicted a positive credit behavior. An increased credit card limit will help you to lower your CUR.

• Make Frequent Card Payments:

If you have the habit of making bulk purchases with your credit card, make sure you make frequent payments on it. Rather than waiting until the due date, you can make frequent small payments between the two due dates. This always helps you to maintain a higher credit card limit. This will help you to keep a low Credit Utilization Ratio.

• Reduce Balances Quickly:

Always make payments well before your due date, as lenders report only the balance of your credit card to credit bureaus. If your credit card balance is low, then it is proportionate to a low credit utilization ratio. This will be very useful when you plan to apply for a new credit card soon. A lower credit utilization will have a positive impact on your credit score.

• Distribute Expenses Across Credit Cards:

If you have multiple credit cards, you can distribute the expenditure across them. Rather than making your payments with a single credit card, you can make the payments across all your credit cards. This will also help you to keep a low credit utilization ratio.

Common Misconceptions of Credit Utilization

Credit Utilization conveys different meanings to individuals. But these can sometimes lead to misconceptions that affect your overall Credit Utilization Ratio (CUR). The following are common misconceptions about credit utilization. They are:

• Closing Unused Credit Cards: Closing unused credit cards might look like a strategic move to improve your credit score. But actually not: closing unused credit cards will shorten the average age of your credit accounts, which will increase your credit utilization ratio.
• Keeping Credit Cards Inactive: When you do not use credit cards for an extended period, it does more harm than good. Lenders might perceive you to be an inactive or unreliable person.
• Having High Credit Limits is Bad: Having higher credit limits on your credit card does not hurt your credit score. Wise usage of a credit card with a higher credit limit will lower your CUR and boost your credit score.
• Carrying a Balance Improves Credit Score: When you have a balance from one month to the next, you pay interest on that balance and can hurt your credit score if your credit utilization ratio is high.
• Use 50% of Your Credit Limit: Using 50% of your credit limit will cause more harm than good. A good credit utilization score is 30%, and an ideal one is 10%. Higher credit utilization indicates that you are too dependent on your credit.

Conclusion

Credit Utilization Ratio is one of the parameters that credit bureaus look into while calculating your credit score. Keeping your credit utilization ratio under 30% will help you reach a good credit score. We have explained the various pointers to be kept in mind to keep your credit utilization low and thereby achieve a good credit score. Keep these points in mind to reach a good credit score and get your premium credit cards and loans approved.