Understanding and managing your credit utilization ratio is crucial for maintaining a healthy credit score. The credit utilization ratio, also known as the debt-to-limit ratio, measures the amount of available credit you are currently using. Calculating this ratio accurately allows you to assess your financial health and make informed decisions to improve your creditworthiness. In this article, we will explore what the credit utilization ratio is, why it is important, and how you can calculate it to make informed financial decisions.
Credit utilization ratio
The credit utilization ratio is expressed as a percentage and is calculated by dividing your total credit card balances by your total credit limits. It measures how much of your available credit you have utilised. For example, if you have a credit card with a limit of Rs. 50,000 and your outstanding balance is Rs. 25,000, your credit utilization ratio would be 50%.
Formula for calculating the credit utilization ratio
To determine your credit utilization ratio, follow this formula:
Credit utilization ratio = (Total outstanding on all credit cards ÷ Total credit limit) × 100
Let us consider an example to better understand the calculation.
Consider a scenario where you have two credit cards with outstanding balances of Rs. 20,000 and Rs. 10,000, respectively. The credit limits on these cards are Rs. 50,000 and Rs. 25,000, respectively.
Total outstanding balance: Rs. 20,000 + Rs. 10,000 = Rs. 30,000
Total credit limit: Rs. 50,000 + Rs. 25,000 = Rs. 75,000
Credit utilization ratio: (Rs. 30,000 / Rs. 75,000) * 100 = 40%
Interpreting your credit utilization ratio
In the above example, the credit utilization ratio is 40%, which means you are utilising 40% of your total available credit. A lower credit utilization ratio is generally considered favourable and indicates responsible credit management. Lenders typically prefer to see a credit utilization ratio below 30%, as it suggests that you are not overly reliant on credit. Higher ratios can be a red flag for lenders and may negatively impact your credit score.
Tips to improve your credit utilization ratio
If your credit utilization ratio is higher than desired, consider the following strategies to improve it:
Pay down your balances: Make efforts to reduce your outstanding balances by paying more than the minimum amount due each month.
Increase your credit limit: Request a credit limit increase on your existing cards or consider obtaining an additional credit card to increase your overall available credit.
Spread purchases over multiple credit cards: Distribute your purchases across multiple credit cards to keep individual card balances low and maintain an overall low credit utilization ratio.
Avoid closing credit card accounts: Closing an account reduces your total available credit, which can raise your credit utilization ratio. Instead, keep unused accounts open to maintain a healthy credit mix.
Monitor your spending: Keep track of your credit card usage and avoid unnecessary purchases that can increase your outstanding balances.
Calculating your credit utilization ratio is an essential step in managing your overall credit health. By maintaining a low credit utilization ratio, you can improve your credit score and increase your chances of obtaining credit at favourable terms. To build a good credit score, consider the Bajaj Finserv Credit Pass, which offers you a complete overview of all your credit accounts so that you can track your payment deadlines and credit utilization with ease and enhance your creditworthiness. Remember, a healthy credit utilization ratio demonstrates responsible credit management and can pave the way to a bright financial future.
