How to Calculate Your Credit Utilization Ratio

Everyone is aware that their credit score matters because it can determine whether they are approved for a mortgage, new credit cards, auto loans, or even rental apartments. But how credit scores are determined is not as obvious. Some of the elements like the length of your credit history and the number of years your credit cards have been active are fairly simple. However, one of the least predictable factors, the credit utilization ratio, is also important and it accounts for 30% of your score.

How to Calculate Your Credit Utilization Ratio

What is a Good Credit Utilization Ratio ?

A low credit utilization ratio is recommended at all times as it shows that the borrower is handling his liabilities responsibly. A higher ratio, however, might be taken as an indication that the borrower is overspending and struggling to control their finances. The majority of credit bureaus recommend that the ideal credit utilization ratio must be less than 30% of the total credit limit.

How Credit Utilization Ratio is Calculated ?

The following formula can be used to determine the credit utilization ratio:

Credit Utilization Ratio = (Total Outstanding Amount/Total Available Credit) X 100

Imagine you have three credit cards, X, Y, and Z, with a combined credit limit of Rs 2 lakh. Additionally, you still owe Rs 22,000 on X, Rs 50,000 on Y, and Rs 9,000 on Z. 

All three cards’ combined outstanding balances total (Rs 22,000 + Rs 50,000 + Rs 9,000), or Rs 81,000. The credit utilization ratio can now be calculated using the formula (81,000 / 2,000 000) X 100 = 40%.

Your credit utilization rate is 44% in this case. The same method can be used to determine the credit utilization ratio for each credit card.

How to reduce the Credit Utilization Ratio?

The best outcome for both your credit utilization ratio and the amount of interest you pay will be to reach a balance of zero as quickly as possible. But we understand that’s not a simple task. You can take the following actions in the short term to increase your utilization:

  • The balance on your card with the highest per-card utilization should be paid off first. Move on to the following card once you reach or fall below 30%.
  • Don’t add to your balance and instead ask your credit card company for a higher limit. You won’t always get one, but it can give you some buffer time.
  • You can usually set up text or email alerts to notify you when your balance reaches a certain level. Set yours to 30% or less so that you will be aware of when you need to stop using your credit card until your balance is paid off.

How Can I Improve My Credit Utilization?

Pay off your debts until they are at least 30% or less if you want to increase your credit utilization. Other options include requesting a higher credit limit, getting a new credit card, or keeping a card that has its balance fully paid open but not being used. The best way to increase your credit utilization is to make on-time debt payments.

Is Having 0% Credit Utilization Good?

It’s not always a good thing to have zero credit utilization. Creditors want to know that you’re able to manage credit and pay off your credit card debt, your credit score won’t likely be harmed, but it also might not be improved because creditors want proof that you can responsibly use credit and repay your credit card debt. Due to this, a low credit utilization rather than a zero credit utilization could be better for your credit score.

Read More: Common Credit Card Myths Damaging Your Credit Score

Conclusion

It’s important to remember that if you raised the credit limit on your card, you should use it responsibly. Furthermore, you must also take precautions and make sure that the card’s security is not compromised whether you use it online or offline. You must purchase a credit card protection plan (CPP) if your card has a high credit limit to prevent unauthorized use of your card. It’s also advised that you establish alerts with your card issuers like HDFC Bank LTD, State bank OF INDIA, ICICI Bank, American Express, Axis Bank, CITI Bank, IDFC Bank, Bank OF Baroda, Kotak Mahindra, Indusland Bank, etc. so that you’ll be informed if a transaction is made without your permission.

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