Credit Utilization Ratio: What It Is & How to Keep It Low

Introduction

In the realm of personal finance, understanding and managing your credit utilization ratio is crucial for maintaining a healthy credit score. This ratio, which indicates how much of your available credit you're using, plays a significant role in determining your creditworthiness. In India, as in other countries, a high credit utilization ratio can negatively impact your credit score, making it harder to secure loans or credit cards with favorable terms. Let's explore what the credit utilization ratio is, why it matters, and how you can keep it low.

What is Credit Utilization Ratio?

Your credit utilization ratio is the percentage of your available revolving credit that you're currently using. For example, if you have a credit card with a limit of ₹10,000 and you've spent ₹3,000, your credit utilization ratio for that card is 30%. This ratio is a key factor in calculating your credit score, accounting for about 30% of your FICO Score. Credit utilization is also sometimes called revolving credit utilization because it only includes revolving credit accounts like credit cards, personal lines of credit, and home equity lines of credit (HELOC). Check out this blog to understand more about credit scores: What Is a Credit Score & Why Does It Matter? A Comprehensive Guide

Why Does Credit Utilization Ratio Matter?

A high credit utilization ratio can signal to lenders that you're overextended or unable to manage your finances effectively. This can make you appear as a high-risk borrower, potentially leading to higher interest rates or even denial of credit. On the other hand, a low credit utilization ratio indicates that you're using your credit responsibly, which can boost your credit score and make it easier to secure favorable terms on loans and credit cards. Check this blog out: How to Improve Your Credit Score in India and Secure Better Loan Deals

How to Calculate Your Credit Utilization Ratio

Calculating your credit utilization ratio is straightforward. You need to know the balances and credit limits of your revolving credit accounts. Here's a step-by-step guide:

1. Find Your Balances and Credit Limits: Obtain your credit report to get the most accurate figures.
2. Add Up the Balances and Credit Limits: Sum the balances and credit limits of all your revolving accounts.
3. Divide and Multiply: Divide the total balance by the total credit limit and multiply by 100 to get the percentage. You can also read 5 Credit Card Mistakes That Can Ruin Your Financial Health

For example, if you have two credit cards with limits of ₹5,000 each, and one card has a balance of ₹2,000 while the other has a balance of ₹1,000, your total available credit is ₹10,000 and your total balance is ₹3,000. Your overall credit utilization ratio is 30%.

What is a Good Credit Utilization Ratio?

A good credit utilization ratio is generally considered to be below 30%. However, aiming for an even lower ratio, such as below 10%, can have a more positive impact on your credit score. According to Experian data, individuals with the highest credit scores tend to have credit utilization ratios in the low single digits.

How to Keep Your Credit Utilization Ratio Low

1. Pay Down Balances Early

One effective strategy is to pay down your credit card balances more than once a month. This can help reduce the balance that gets reported to the credit bureaus, thereby lowering your credit utilization ratio. For example, if you typically spend ₹5,000 a month on your credit card, try making two payments of ₹2,500 instead of one payment of ₹5,000 at the end of the month.

2. Request a Higher Credit Limit

Asking your credit card issuer for a higher limit can increase your available credit, thereby lowering your utilization ratio. However, ensure that you don't increase your spending just because you have more credit available. For instance, if your current credit limit is ₹10,000 and you request an increase to ₹15,000, your utilization ratio will decrease if your balance remains the same.

3. Avoid Closing Credit Cards

Closing credit cards can reduce your overall available credit, which can increase your credit utilization ratio. Instead of closing cards, consider keeping them open and using them occasionally to keep the accounts active. Check this out: Should You Close Old Credit Cards? The Pros & Cons

4. Use Cash or Debit Cards

Using cash or debit cards for purchases can help you avoid increasing your credit card balances. This is particularly useful if you're struggling to keep your spending under control.

5. Consolidate Revolving Debt

If you have high balances on multiple credit cards, consider consolidating your debt with a personal loan or a balance transfer credit card. This can help you manage your debt more effectively and lower your credit utilization ratio. Check this blog out: The 50/30/20 Rule: A Foolproof Way to Manage Your Money

Conclusion

Managing your credit utilization ratio is a key aspect of maintaining a healthy credit score. By understanding how it's calculated and implementing strategies to keep it low, you can improve your financial health and increase your chances of securing favorable terms on loans and credit cards. Remember, a low credit utilization ratio not only boosts your credit score but also demonstrates responsible credit management to lenders. For those in pursuit of their dream home, investment opportunities, or a sanctuary to call their own, Jugyah provides top housing solutions with its intelligent technology.

Frequently Asked Questions

Q1. What is a good credit utilization ratio?

A good credit utilization ratio is below 30%. However, aiming for an even lower ratio, such as below 10%, can have a more positive impact on your credit score.

Q2. How often should I check my credit utilization ratio?

It's a good idea to check your credit utilization ratio monthly, especially if you're working on improving your credit score. You can use online tools or credit card statements to monitor your balances and limits.

Q3. Does paying off my balance in full every month affect my credit utilization ratio?

Yes, paying off your balance in full every month can help keep your credit utilization ratio low. However, it's also important to keep an eye on the balance that gets reported to the credit bureaus, which may not always reflect your current balance.

Q4. Can I have a credit utilization ratio of 0%?

While a 0% credit utilization ratio might seem ideal, it's actually better to have a low utilization rate, such as 1% to 2%. This shows lenders that you're actively using your credit and managing it responsibly.

Q5. How quickly can I see an improvement in my credit score by lowering my credit utilization ratio?

Improvements in your credit score can be seen relatively quickly once you lower your credit utilization ratio. Since credit utilization is a significant factor in your credit score, reducing it can have a positive impact within a few months.