What is Credit Utilization Ratio - Everything You Need to Know

Currently, most people rely on credit to afford the lifestyle they wish to live. Credit cards allow people to afford important things in life and pay for them later. However, borrowers must know that they must pay for these things eventually. Many borrowers make the mistake of paying only the minimum due on their account when they should ideally clear the entire bill each month. In this article, we try and understand the concept of credit utilization ratio and try to understand how it affects a borrower's CIBIL score.

What is Credit Utilization Ratio?

An individual's credit utilization ratio is the ratio of used credit to available credit. Depending on the scoring model that one uses, the credit utilization ratio can be responsible for up to 20% to 30% of an individual's credit score.

When an individual takes a credit card but does not use it, their credit utilization ratio automatically becomes zero. As soon as they start using their credit card, their credit utilization ratio takes a number. A high credit utilization ratio is a sign of a spendthrift borrower and lenders do not want to lend money to such borrowers. Borrowers should maintain a low credit utilization ratio, i.e. they should never exhaust the credit limit on their credit cards.  

If your credit utilization ratio goes up once in a while, it won't affect your CIBIL score. However, if your credit utilization ratio or rate is consistently high, your credit score will most certainly get affected.  

How to Calculate Credit Utilization Ratio?

It is quite easy to calculate your credit utilization ratio. Simply divide the balance available on your credit card by the total limit on your credit card and you will have your credit utilization ratio. 

Therefore, credit utilization ratio = (Total outstanding on all credit cards/ Total credit limit) x 100 

Let us understand this with an example. If you have two credit cards with a total limit of Rs.1 Lakh with an outstanding balance of Rs.20,000 on one card and Rs.30,000 on another card.  

This way, your credit utilization ratio is calculated as: 

The total outstanding balances on both the cards: Rs.20,000 + Rs.30,000 = Rs.50,000 

The total credit limit = Rs.1 Lakh 

The credit utilization ratio on your card is: (50,000/1,00,000) x 100 = 50% 

This means your credit utilization ratio is 50%.  

What is a Good Credit Utilization Ratio? 

If you want to be approved for loans quickly, your credit utilization ratio must not exceed 30%. 30% is considered ideal by lenders. If your credit utilization ratio is not as good as it should be, don’t worry. By following a few simple tips, you can improve your credit utilization rate. Read on to know about these tips.

Simple Tips to Help You Improve Your Credit Utilization Ratio

Clear Credit Card Bills on Time

If you want your credit utilization ratio to go up, you must learn to clear credit card bills on time. Borrowers prefer credit cards as they allow them to buy things and pay for them later. However, borrowers must understand that it does not matter whether they are using a credit card, they must pay for it eventually. Therefore, borrowers must use their credit cards judiciously and never exhaust the limit on them.

Further, they should learn to fall into the habit of paying the entire amount due on their credit card. When borrowers use a credit card to buy things, they must clear the entire amount due and not just the minimum amount due. Clearing only the minimum amount due reduces one’s credit utilization ratio over time.

Request Your Lender to Increase the Credit Limit on Your Credit Card

If you have been a good credit card user and have maintained a good relationship with your lender, you can ask your lender to increase the credit limit on your card. Doing so would automatically reduce your credit utilization ratio. However, you must do so after proper planning and only when you know you can handle a higher credit limit. Sometimes, borrowers ask for a higher credit limit and then end up exhausting it. This can end up ruining your credit utilization ratio further. So, go for this step only after proper planning.

Consider Using Different Cards for Different Purposes

Yet another way you can increase your credit utilization ratio is by using different credit cards for different transactions. This will help you maintain a low credit utilization ratio on all your credit cards. Again, only those borrowers who can control how they spend money on their credit card should opt for this step.

Also Read: Ways to Improve Your Credit Score with a Credit Card

Final Words

If you are planning to avail of a loan of any kind, be it secured on unsecured, you must know that availing yourself of a loan will become possible only if you meet your lender’s CIBIL score requirement. Borrowers must have a CIBIL score of 750 or above to be eligible for a loan. An individual’s CIBIL score depends on several factors, such as their credit history, credit utilization ratio or credit exposure, new credit availed of, etc. Maintaining a good credit history is important and so is maintaining a good credit utilization ratio. While most borrowers know how to maintain a good credit history, most are clueless about how to improve their credit utilization ratio. We hope this article proved to be a helpful read in this regard.

Also Read: Tips to Maintain Your Business CIBIL Score Above 700