What is a Credit Utilization Ratio, Calculation & How To Improve?

Understanding Credit Utilization Ratio

A good credit score is a testament to healthy financial habits. This doesn’t only help you get the best terms of borrowing but also makes it easier to avail of instant loan online right when you need it.

Of the several factors that shape your overall credit profile, the credit utilization ratio plays a significant role in the same.

The credit utilization ratio is nothing but the percentage of credit you have used from your available limit. And working towards maintaining a healthy credit utilization ratio can help you build a strong credit profile and credit score.

Keep reading this blog to understand how to achieve the same.

Importance of Credit Utilization Ratio

Maintaining a healthy credit utilization ratio goes beyond availing high-value loans. Here’s why it’s important:

Reduces Financial Stress:

A lower credit utilization ratio means a lower loan amount to pay back to the lender. This can significantly reduce your financial burden and obligation.

Improves Your Credit Score:

Keeping your credit utilization below 30% can help you increase your credit score which automatically improves your loan eligibility and creditworthiness.

Easier Access to Credit:

A higher loan eligibility automatically makes you a low-risk borrower in the eyes of a lender. This increases your eligibility and even makes you eligible for online personal loan of up to 5 lakhs.

Best Terms of Borrowing:

Easier access to credit is not all that you get with a low credit utilization ratio. It also comes with the most favourable terms of borrowing like higher personal loan interest rates, instant approval, quick disbursals, and flexible personal loan repayment options.

How Does Credit Utilization Work?

When evaluating your personal loan eligibility, a lender will check your credit utilization ratio to evaluate the risk associated with providing you credit.

This is calculated based on the total credit limit you use from the total available credit limit provided.

Credit rating agencies use this metric to evaluate your credit score which plays a significant role in determining your creditworthiness.

The best practice is to ensure that your credit card utilization ratio is below 30%.

How to Calculate Credit Card Utilization Ratio?

This is the formula to calculate the credit card utilization ratio:
Credit utilization ratio = (Total outstanding on all credit cards/Total credit limit) * 100.

Here’s an example for better understanding:
Consider you have 3 credit cards with a credit limit of Rs. 20000, Rs.10000, and Rs.50000. Of these, your outstanding is Rs. 5000, Rs. 5000 and Rs. 30000 respectively.

Your total outstanding on all credit cards = 5000 + 5000 + 30000 = 40000

Your total credit limit = 20000 + 10000 + 50000 = 80000

Credit utilization ratio = (40000/80000) * 100 = 50%

Typically, this will be considered as a very high credit utilization ratio.

Credit Card Utilisation Limit

If you’re a credit card holder, it’s extremely important to know that you’re supposed to keep your utilization below 30%. This means if your credit card limit is Rs. 100000 then your credit card utilization shouldn’t cross Rs. 30000.
You can always apply for a new credit card once you have utilized 30% of your limit. This way, you will not only maintain a healthy credit card utilization ratio but also improve your eligibility for a higher limit.

You can use a free credit utilization calculator online to check your ratio to keep track of the same.

What is a Good Credit Utilisation Rate?

The best credit utilization rate can look different among different types of credit providers and financial institutions. However, the best practice is to keep it below 30%, especially when it comes to credit cards.

This reduces the financial burden of your repayments and improves your overall credit health.

Factors Affecting Credit Utilization Ratio

Your Credit Limit:

The most important factor that can affect your credit utilization ratio is the approved limit across all your credit cards and loans. If you are someone who requires a large sum of money to meet your needs, then you will require a higher credit limit to maintain a healthy utilization ratio.

New Credit

Opening new credit accounts can also impact your overall credit utilization ratio. This is because it increases your available limit, potentially decreasing your utilization ratio.

Closing Old Credit Accounts:

Closing old credit accounts decreases your available credit limit which can decrease your overall utilization ratio.

Tips to Improve Credit Utilisation Ratio

A low credit utilization ratio is extremely important for maintaining a strong credit profile. You can achieve this by following a few simple steps:

Spend In Your Limit:

The first thing to reduce your credit utilization ratio is to decrease your spending. This will decrease your utilization across all your credit cards and loans which will automatically keep your utilization ratio in check.

Pay The Entire Outstanding Amount Every Month:

When paying back your credit card bills or EMI, make sure you repay the entire outstanding balance in full and not just the minimum amount.

Apply For A Higher Credit Limit:

One of the easiest ways of reducing your credit card utilization ratio is simply applying for a higher credit limit. Doing this increases your available limit, potentially decreasing your utilization ratio.

Apply For New Credit Cards:

If you have utilized more than 30% across all your credit cards, you can apply for a new credit card. This doesn’t only reduce your credit utilization ratio but also increases your purchasing power.

Conclusion

A strong credit profile and good credit score are a golden ticket to high-value loans with the best terms of borrowing. Maintaining a healthy credit utilization ratio is one of the most efficient ways of achieving the same.

Making minor tweaks in your spending habits and applying for higher limits can help you reach a utilization ratio of 30%.