Credit Scores Are Important, But What About Credit Utilization Ratio? A Closer Look Here

Credit Utilization Ratio: Although the majority of borrowers are aware of credit scores—whether through loans or credit cards—they are not familiar with the idea of credit utilisation ratio. If you intend to borrow in the future, you must have a good (high) credit score. However, it is crucial to comprehend the credit utilisation ratio because it directly affects the credit score.

Understanding Credit Scores

A credit score is determined by a number of things. The principal factors are a person's credit repayment history, credit utilisation percentage, credit history duration (years), credit mix, etc. Put simply, it shows you how much of your credit limitations are being used at the moment. In technical terms, it is the ratio of the total credit limit—that is, the entire amount of credit you are permitted, including amounts borrowed—across all of your loans and credit cards to the outstanding loan/credit card dues across all of your loans and credit cards.

How to monitor your credit utilisation ratio

• Never go over your budget or spend money needlessly. Spending on credit cards should be kept to a minimum—amounts you can afford to pay off in full by the next deadline. Avoid the mistake of only making the minimum amount due (MAD) payments on your credit cards.
• It's not necessary to constantly try to use your credit limit on a card with a high credit limit.
• Increasing your credit limit is an additional option. Therefore, the first thing to do is to determine whether you are spending money needlessly if your credit limit is Rs 2 lakh and you consistently wind up using Rs 70,000 (that is, 35 percent credit utilisation and beyond the suggested 30 percent). Additionally, you can request an increase in your credit limit from your card issuer. This will, provided you don't raise spending, automatically drop your utilisation ratio.
• Don't use up all of your credit limit on a single card if you have many credit cards. Spreading out your spending will help you keep low utilisation ratios on all of your cards. It's also acceptable to use one card moderately and put other cards on hold for a few months.

Exploring a Credit Utilization Example

Assume you have a Rs. 5 lakh credit limit. Additionally, you owe Rs. 1.5 lakh and Rs. 1 lakh on two credit cards. Your credit usage ratio in this scenario would be 50% (Rs 2.5 lakh / Rs 5 lakh). It should be clear from the foregoing that your credit utilisation ratio will increase with the amount you spend (on credit or loans). This ratio is highly significant not only for determining credit score but also for providing lenders with information about an individual's credit behaviour. Responsible credit behaviour is indicated by a lower credit utilisation ratio, which generally raises credit score. However, if the ratio is large (and that too continuously), it may be a sign of financial stress or a heavy reliance on credit for the person.

Varied Guidelines Among Credit Bureaus

There are differences in the good/bad thresholds among credit bureaus. Generally speaking, it is advised to keep the entire credit utilisation ratio around 30%. Thus, it is wise to keep your outstanding debts to 30% of your total credit limit, or Rs 1.8 lakh, if your credit limit is Rs 6 lakh. To be fair, if you need to spend on emergencies or non-negotiable costs every now and then, it's acceptable to go over the suggested 30 percent ratio. However, a persistently elevated credit utilisation ratio need to be avoided. Thus, it's better to make an effort to typically stay below 25–30 percent. It goes without saying that you should never borrow money unless it is absolutely required.

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