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Credit Utilization Ratio: Things you must know

ICICIdirect 8 Mins 03 Nov 2023

In the world of personal finance, you must learn to manage your credit, as it can significantly impact your financial well-being. Your credit health is measured by your credit score. You may want to have a good credit score for various reasons. Do you know the reasons? Maybe we will cover that in some other article.

How do you how you can improve your credit score? Different parameters impact your credit score, and one of the most crucial parameters is the credit utilization ratio. The parameter can impact up to 30% of your credit score, and therefore, needless to say, you must know about it. In this article, we will talk about everything you need to know about credit utilization ratio.

What is the Credit Utilization Ratio?

Let us start by understanding the term - Credit Utilization Ratio (CUR). It is a percentage that represents the amount of credit you are currently using compared to the total credit available to you. It's a significant factor in determining your creditworthiness and can influence your credit score. In simple terms, it's the ratio of your credit card balances to your credit limits. Once we take an example, you will understand it better.

Importance of Credit Utilization Ratio

Next, let us discuss why you need to know your credit utilization ratio. Below are points to highlight its importance:

  • Credit Score Impact: As mentioned earlier, your credit utilization ratio plays a substantial role in shaping your credit score. High credit card balances relative to your credit limits can lower your credit score. A lower CUR indicates responsible credit management and positively affects your creditworthiness.
  • Lender Assessment: When you apply for credit, lenders often scrutinize your CUR to assess your ability to manage credit responsibly. A high CUR might signal financial stress, making you appear as a riskier borrower in the eyes of lenders.
  • Credit Limit Management: Maintaining a healthy CUR encourages your credit card issuer to increase your credit limit over time. A higher credit limit can deliver more financial flexibility and lower your CUR if you maintain your spending patterns.

So next time, when you receive a message for a higher credit limit, what are you going to do? Do you see the benefit of having a higher credit limit? If not, complete the article, and you will know.

Credit Utilization Ratio: Calculation

Let us look at how you can know your Credit Utilization Ratio. The formula for it is simple:

Credit Utilization Ratio (%) = (Total Credit Card Balances) / (Total Credit Limit) x 100

Let us explain it with an example. Let us assume you have three credit cards, and the limit and balance look something like the below:

Card A

  • Credit Limit: Rs 10,000
  • Current Balance: Rs 2,500

Card B:

  • Credit Limit: Rs 5,000
  • Current Balance: Rs 1,000

Card C:

  • Credit Limit: Rs 15,000
  • Current Balance: Rs 3,500

You need to sum all credit limits, which for the above cards is (10000 + 5000 + 15000) Rs 30,000. The credit balance is Rs 7,000.

Now applying the above formula, CUR = (7000/30000) * 100 = 23.33%

What does it mean? It means that you are using about 23.33% of your available credit. 

Things to keep in mind regarding CUR

Here are the things to keep in mind regarding the credit utilization ratio:

Aim for a Low CUR: Do you want to know - what is a good CUR? As per financial experts, typically, maintaining a CUR below 30% is good for your credit score. It means that if your credit limit is Rs 1,00,000, your outstanding balance should ideally be under Rs 30,000. Lower ratios, such as 10% or less, are even better for your credit score.

Regularly Monitor Your CUR: Keeping track of your CUR is essential. You can check your credit card statements or contact your credit card issuer to know your credit limit and current balance. Ensure that this information is reported accurately to credit bureaus.

Pay Credit Card Bills on Time: Consistently paying your credit card bills on time helps you maintain a low CUR. Late payments not only attract fees and interest but can also increase your CUR, negatively affecting your credit score.

Consider Multiple Credit Cards: Having multiple credit cards can help improve your CUR if you distribute your balances wisely. However, avoid opening too many new accounts within a short period, as it can impact your credit score.

Don't Close Old Credit Accounts: The length of your credit history is another factor affecting your credit score. Closing old credit accounts can reduce your total credit limit and potentially raise your CUR. It's often wise to keep old accounts open, even if they are not actively used.

Before you go

Your Credit Utilization Ratio is a critical element of your overall credit health. We hope you can now keep track of it, and if you see your credit score going down, you can figure out if CUR is the reason. Please maintain a low CUR, regularly monitor your credit accounts, and use credit responsibly are essential steps toward financial stability and a strong credit score. By understanding the significance of the CUR and practicing responsible credit management, you can ensure a solid financial foundation for your future endeavors.

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