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Why is the credit utilization ratio relevant to your credit score?

What is Credit Utilizations Ratio?

Credit utilization ratio is the measure to understand how you utilize your revolving credit limits like credit cards. It normally refers to the amount of usage against your available borrowable limit.

Credit cards, personal and business lines of credit, and home equity lines of credit are different types of credit. It is also known as the credit utilization rate or credit usage rate. It is normally expressed as a percentage.

How is the Credit Utilization Ratio calculated?

  1. Calculate the total outstanding as of the date on all your revolving credits.
  2. Find the total credit limit available on the revolving credits.
  3. Divide Step 1/Step 2
  4. The ratio shall be ideally below or equal to 30% or 0.3.
  5. Credit utilization ratio can also be calculated per facility or credit.

For example, you have a business flexi loan with a limit of Rs 3,50,000. Your outstanding balance is Rs 85,000. Then your credit utilization ratio is 24.28%. This means you are using one-quarter of your available credit limit.

Why is the ideal credit utilization ratio 30% or below?

It means that you are very less dependent on credit. You are managing your debts decently. Your credit score will be intact and you will have a good credit history. You will have access to new loans when needed considering your ideal credit usage and also your high credit score.

Any ratio higher than 30% would reflect that your spending pattern is irregular and you could end up borrowing more than you need. Also, a ratio of more than 30% means you are repaying less and using more. You could end up pushing your credit profile as risky.

Is it good to have 0 credit utilization?

No. Then you don’t need any credit facility. It does not go well with the lenders. You should use your credit facility judiciously. Credit utilization of 1-10% helps in achieving a good credit score.

The lenders will be interested to provide credit facilities with better offers when you require them. It is better to have a single-digit score and not more than 30 but not zero. It can also be a healthy target to achieve a credit usage rate below 10%.

How to reduce my credit utilization ratio?

Pay your credit card bills regularly:

The credit card bills should be paid in full every month. You can also make multiple small payments throughout the month if you feel the pinch of making it a single bulk payment. Multiple payments also help in reducing the overall outstanding balance of your credit card.

You can be assured that your credit utilization ratio is not affected even when the lenders report your outstanding to the credit bureau before your billing cycle. This will also help you in reducing interest charges if any on your credit card.

Some lenders also go for per card utilization rate. So there comes a check to proceed with caution in calculating your credit utilization ratio.

Alternatively, you can opt for a balance transfer if you are unable to clear high outstanding amounts. This should be done with discretion as it could take a toll on your financial discipline.

Don’t use but don’t close

Having more than one can increase your available credit limit thereby reducing the credit utilization ratio. Also, you will be tempted to spend more. It is advisable to use one credit card and keep the other credit cards with zero utilization.

Alternatively, you can sum up the available credit limits on all your credit cards. Calculate 25% to 30% on it. Spread your spends across your credit cards but limited it to 30% of your total available credit limit.

If you have utilized 30% of your credit card limit in a month, do not use the cards until you repay and keep the spends to the minimum possible. It is advisable not to make any high-value purchases through your credit card to achieve a good credit utilization ratio.

Apply for an increase in credit limit

Keeping a check on your credit utilization ratio will help in achieving a good credit score. Lenders review credit limits once every 12 to 18 months. Considering your credit history and credit score, your lenders may offer an increase in credit limit for your existing credit card.

You can apply for the same, even though you do not need it. Ensure your spending pattern is the same even with an increased credit limit. This will largely help in reducing your credit utilization ratio.

Also Read: Business Car Loans for People With Bad Credit History

Is credit utilization ratio all about my credit usage?

Credit utilization ratio is both about your available credit limit and credit usage. It is an inversely proportional ratio. When your

Credit limits are higher than credit usage = Low credit utilization ratio

Credit limits are lower than credit usage = High credit utilization ratio

Hence your endeavor must be towards keeping a check on your spending, paying the bills regularly, and also towards increasing your credit limits.

Take away:

Credit utilization is the second most important factor in calculating your credit score. It is not practically possible at many times to be perfect with the ratios. But monitoring your credit usage can inculcate discipline in managing your finances.

You will eventually understand how to cut off the weeds from your spending. You will also not fall prey easily to illegitimate offers.

Conclusion:

Credit utilization ratio is the measure that analyses beyond regular payments. It emphasizes multiple important factors like availability, utility, and repayment of credit. Hence every credit card holder needs to keep track of their credit utilization ratio to achieve a good credit score. You can make use of any credit more…

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