The Credit utilization ratio is one of the key ingredients in determining your credit score, so it’s crucial to understand how it works. After all, a good credit score can qualify you for higher loan amounts and lower interest rates, while a low credit score can make it difficult to reach your financial aspirations. In this blog, we’ll try to cover everything you need to know about credit utilization, including:
- What is the credit utilization ratio?
- How is the credit utilization ratio calculated?
- What is a good credit utilization ratio?
- How to improve the credit utilization ratio
Let’s Begin With What is Credit Utilization Ratio?
Your credit utilization rate, sometimes called your credit utilization ratio, is the ratio of your credit card outstanding to your credit limit. They can impact up to 20-30% of a credit score, depending on the scoring model being used. If you never use your credit cards and there’s no balance on them, your credit utilization would be zero. If you typically carry a balance on one or more cards, you are utilizing some of your available credit lenders and credit bureaus will take note. While a one-off higher utilization rate for your credit cards may not really impact your credit score, your credit score will certainly be impacted adversely if the credit utilization rate continues to be higher on a regular basis.
How is the Credit Utilization Ratio Calculated?
Credit utilization ratios can be calculated for each credit card (card balance divided by card limit) and on an overall basis (total balance on all cards divided by the sum of credit limits). For instance:
|Balance||Limit||Credit Utilization Ratio|
Total Credit Card Balance / Total Available Credit =Credit Utilization Ratio
Total credit utilization ratio in this case will be 40%.
What is a Good Credit Utilization Ratio?
The general rule of thumb with credit utilization is to stay between 30-40 percent. This applies to each individual card and your total credit utilization ratio. Anything higher than the above-mentioned percent can cause a dip in your credit score as lender relate this to a credit hungry behaviour. This doesn’t mean that one cannot ever cross 40% of the credit utilization on any card. The impact on credit score is more only if high utilization seems to be a common pattern over last 6-12 months.
Finally, improve your credit utilization rates and eventually your credit score through these smart moves:
1. Paying credit cards on a more frequent basis – While you may be using your credit cards for availing the card benefits on different transactions, try to reduce your credit card outstanding by more than minimum each month and paying more frequently. For example, even while the credit card statement is generated on a monthly basis, you may keep paying your credit card outstanding every 10 days. As such, your credit limit will keep getting replenished and thus, your credit utilization rates will be visible as low.
2. Availing a Higher Credit Limit – Just in case you believe that you can effectively toggle between credit card dues and your regular payments, you can ask for a higher credit limit from your bank. Given the current credit card usage remains to be the same, the credit utilization rate will automatically reduce as the usable limit has increased. However, in such times, you should be careful that having a higher credit limit may also tempt you to spend more.
3. Using Multiple Credit Cards for Managing the Limits effectively – In case you are holding multiple credit cards, try to use different cards for different transactions instead of using a primary credit card for all the transactions. Accordingly, you will have a lower credit utilization rate across all the credit cards, instead of having a very high utilization rate for one card and very low/ nil utilization for the other cards.
4. Leave cards open after paying them off- By paying off the card, you’re reducing your total balance. By keeping the card open, you’re maintaining your total credit limit thereby lowering your credit utilization ratio.