What Is Credit Utilisation Ratio And How Does It Determine Your Credit Score?

A credit score is a crucial aspect of your financial life as it affects your capacity to avail of a credit facility or land a job. Nevertheless, did you ever consider how your credit score is calculated? Several factors go into determining your credit score, and one of the most significant ones is your credit utilisation ratio. This ratio shows how much credit is available for you compared to how much credit you are using, which can have a big effect on your credit score. This article explains how your credit utilisation ratio affects your credit score and how you can control it so you can keep a healthy credit score.

What is Credit Utilisation Ratio?

The credit utilisation ratio, also known as the debt-to-credit ratio, indicates how much credit you are using compared to the total amount of credit you have available. You can compute it as a percentage by dividing all of your credit card balances by all of your available credit limits.

For example, if you have a credit card balance of Rs 50,000 and a credit limit of Rs 2 lakhs, your credit utilisation ratio is 25% (50,000/2,00,000 = 0.25 or 25%).

This ratio is used by lenders and credit bureaus to evaluate your creditworthiness and how responsibly you handle your credit. A high credit utilisation ratio may indicate that you have overextended your credit or are at risk of defaulting on your repayments. A low credit utilisation ratio, on the other hand, shows that you are managing your credit well, which is viewed as a sign of creditworthiness.

Since your credit score influences your credit utilisation ratio, it is advisable to keep your credit utilisation ratio below 30% to ensure you maintain a high credit score. The higher the credit utilisation ratio, the more negative impact it can have on your credit score.

Hence, it is critical to manage your credit wisely, make on-time repayments, and maintain low balances to keep your credit utilisation ratio low. By doing this, you will be able to keep up a high credit score and improve your chances of getting loans and other credit facilities authorised.

How Does a Credit Utilisation Ratio Affect Your Credit Score?

A credit score is a three-digit number that represents your creditworthiness. It is determined based on a number of things, such as your repayment history, length of credit history, types of credit used (secured or unsecured), new credit inquiries, and credit utilisation ratio.

The credit utilisation ratio shows how much of your available credit you are using. So, a high credit utilisation ratio means that you are using a significant portion of your available credit, which can be seen as a sign of financial strain or irresponsible borrowing practices and can thus lead to a lower credit score.

On the other hand, a low credit utilisation ratio shows that you are using only a small portion of your available credit, which can be an indication of good credit management and it can raise your credit score.

To maintain a high credit score, it is best to keep your credit utilisation percentage below 30%. Your credit score may suffer if your credit utilisation ratio is greater than 30%, which would make it more difficult for you to access loans and credit cards.

Hence, it is crucial to appropriately manage your credit in order to keep your credit utilisation ratio low by keeping your credit card balances low, paying your EMIs and credit card bills on time, and avoiding unnecessary debt. This will increase your chances of availing of credit facilities in the future by proving to lenders and credit bureaus that you are a trustworthy borrower.

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How to Reduce Your Credit Utilisation Ratio?

Here are 5 proven tips to reduce your credit utilisation ratio:

1. Do not use the entire credit limit:

You need not necessarily utilise your entire credit card limit just because you have a high limit. Adhering to the 30-70 rule and limiting your credit spending can help you maintain an appropriate credit utilisation ratio.

Suppose, even after trying to limit the credit spending, you exceed the 30% limit on one credit card. In such a case, you can balance it with your other credit cards. You can either freeze them until the outstanding balance on the first card is paid off or use the minimum amount possible. This will ensure that your average utilisation ratio remains below 30%. To maintain this low utilisation ratio, you should monitor the expenses on all your credit cards and do the necessary calculations every month.

2. Repay the full bill on time:

It is essential to pay your credit card bills in full and on time every month to reduce your credit utilisation ratio. Paying the minimum amount due can lead to high interest charges and an overall higher credit utilisation ratio.

3. Do not use all credit cards:

It is not wise to use all your credit cards at once if you have many. Your likelihood of exceeding your credit limit increases with the number of credit cards you use, which will increase your credit utilisation ratio.

4. Request to increase your credit limit:

Increasing the limit on your current credit card(s) is/are another way to lower your credit utilisation ratio. As a result, you will use less of your credit limit overall because you will have more credit available. You can request an increase in your credit limit through internet banking or your online credit card account. Be aware, though, that raising your credit limit can make you more tempted to spend money.

5. Apply for a new credit card:

Your credit utilisation ratio might also be lowered by applying for a new credit card. This is because you will spend a lower proportion of your credit limit, as having more credit cards will increase your overall credit limit. However, be mindful that applying for too many credit cards in a short period of time will harm your credit score.

To conclude:

Your credit score can be severely impacted by a high credit utilisation ratio, whereas a low credit utilisation ratio can help you keep your credit score in good standing. By timely monitoring your credit card accounts, making timely full repayments of all outstanding balances, and avoiding needless debt, you can efficiently control your credit utilisation ratio.

It is advised to keep your credit utilisation ratio around 30% in order to retain a strong credit score. A high credit score can benefit you with lower interest rates and easier access to financing.

Managing your credit utilisation ratio is essential for maintaining a healthy credit score. By following the tips outlined in this article, you can reduce your credit utilisation ratio, improve your credit score, and achieve your financial goals.

KETKI JADHAV is a Content Writer at PersonalFN since August 2021. She is an MBA (Finance) and has over seven years of experience in Retail Banking. Ketki specialises in covering articles around banking, insurance, personal finance, and mutual funds and has been doing it for over three years now.