Did you know that the amount you spend using your credit cards is an important metric being tracked monthly? The credit utilisation ratio allows banks and other credit card providers to calculate your credit score.
It is defined as the total credit expenditure from all your credit cards divided by the revolving credit available from all those cards. The credit utilisation ratio is expressed in terms of percentage.
Your credit card utilisation communicates your spending habits to banks and other financial institutions through your credit score. But how is your credit utilisation rate calculated? Stay with us as we dive into the specifics of the concept and discuss the relevance of maintaining a low credit utilisation ratio.
The credit card utilisation ratio is strictly based on revolving credit from credit cards, not including loans for other purposes.
Revolving credit operates straightforwardly. As the name suggests, it does not have a fixed repayment date and carries over to the next month. Once you are eligible to receive a pre-determined amount of credit from your bank monthly, you have two options:
Your pre-decided credit limit is the maximum amount available to you every month. While borrowing, you can receive credit as long as the accrued amount is within the provided limit.
Take a hypothetical situation where you possess a credit card with a limit of INR 1,00,000 per month. If the total expenditure from the card amounts to INR 50,000, it signifies that you are merely using 50% of the available credit.
Banks and other financial institutions look favourably upon a low credit utilisation rate, owing to the following reasons:
Credit utilisation rates are also the most influential factors in deciding your credit score. Hence, it is a good idea to maintain low debts on your credit cards to gradually increase your score and secure eligibility for future loans.
The calculation of the credit utilisation rate starts with the sum of all existing credit sources. For instance, assume Person A has three accounts with the following balances:
The first step for calculating the credit utilisation ratio is adding up the total revolving credit available. In this case, the amount comes up to ₹1,80,000. Next is the total debt incurred from all these credit sources, which amounts to ₹75,000.
Credit card utilisation ratio = The total credit used/Total revolving credit available.
Using this formula, the total credit utilisation ratio for Person A is approximately 42%. However, it is recommended to maintain a rate of 30% or lower every month to increase your credit score.
Your credit utilisation ratio summarises your spending habits to credit lending organisations. It is vital to maintain a respectable score through timely payments of credit card payments and avoiding the build-up of surplus debt.
If you need help managing your finances, look no further than Fi Money! You can clear all money-related queries with tools like Ask.Fi, an intuitive finance personal assistant. Open a zero-balance saving account with Fi and take advantage of features that promote better money habits and help you fulfil your financial goals.
Track and spend your money seamlessly as Fi eases the categorisation of your daily, weekly and monthly spending!
30% or lower is a good credit utilisation ratio that helps increase your credit score.
With 0 credit utilisation, you don't incur any disadvantages or advantages. It does not contribute to increasing your credit score and provides no benefits. It is recommended to maintain a low credit utilisation rate instead.
