Manage Money

What Is a Good Level of Credit Utilization?

Temptations are hard to resist. When you subscribe to a new credit card (especially your first credit card), a whole new avenue of potential expenditure opens up before you with a warm smile and welcoming arms. You suddenly find a lot of "free money" inviting you to spend them. Being a newbie, you might not even know how the credit system works.

You give in to the lure and land in trouble. If this hasn't been the story of your life, then I salute your discipline and self-control. However, if you feel that you could fall prey to similar temptations, read this article for some essential tips to manage your finance well.

Many credit card users fail to understand the concept of credit utilization. Let's quickly acquaint ourselves to it.

What is Credit Utilization?

Let's say that you have a credit card with a credit limit of Rs.1,00,000. You have made a purchase worth Rs.30,000 using the same credit card. The ratio between these two values is your Credit Utilization. To put it lucidly, it refers to the amount or percentage of your credit limit that you have used. In this case, it is 30%. Here is how you can calculate your credit utilization:

( 30,000 / 1,00,000 ) * 100 = 30%

If you have multiple credit cards, you can add the balances in each card to get your total credit balance. Similarly, add the credit limit on each card to get the total credit limit. Now apply the formula to these new numbers to find your overall credit utilization rate.

How Does My Credit Utilization Affect My Credit Score?

Low credit utilization is the best way of maintaining a high credit score. It shows that you are keeping your expenses within limits by using a small amount of credit. A low utilization rate, not exceeding 30%, is considered best for your credit score.

The credit utilization ratio in each of your credit cards is taken into account by the credit bureaus to determine your credit score - individually as well as collectively.

Negative Impacts of High Utilization Rates

A high rate of credit utilization will bring down your credit score. It indicates that you are overspending and might not be able to pay your bills on time. If you don't manage to repay on time, a high rate of interest applies to the principal borrowed amount. So you would end up paying more than what you have actually borrowed, and your funds will gradually deplete, leaving you with less money in your pocket in the long run.

Tips for Maintaining the Right Percentage of Utilization 

Now that you know that you should cap your expenses within a 30% credit utilization rate, you might as well go through these quick tips to help you with it.

  1. Multiple Credit Cards

Let's say your monthly credit card expense is Rs.50,000. You have a single credit card with a credit limit of Rs.1,00,000. It means that your credit utilization rate is 50%, which might be harmful to your credit score. Solution? Take another credit card; spend from both, ensuring that you don't cross your monthly quota of Rs.50,000. Your credit utilization rate drops to 25%, which would not be detrimental to your credit score.

  1. Pay Bills More Frequently
    If your credit card bill tends to shoot up by the end of your billing cycle, you should make payments more than once per month. This will balance out the excess credit utilization.

  2. Increase Your Credit Limit
    Ask your card issuing company to increase your credit limit. If you have used your credit card responsibly and if your credit score meets their requirements, you might be eligible for a higher credit limit. Once done, your average credit utilization will drop. It could be a more suitable option than taking a new card, as a new credit card might bring along an extra subscription fee. However, you need to keep two things in mind: don't increase your expenses; also remember that an application for a new line of credit calls for a hard inquiry, which negatively impacts your credit score.

  3. Keep Your Utilization Above Zero Percent
    You might freak out by the complications and decide not to use your credit card at all. Sounds sensible, right? Well, absolutely not! Banks are here for business. The banks don't profit if you keep your credit card locked up in a safe. They want you to use your credit card responsibly, not avoid it altogether. You must use your credit card to be creditworthy, but at the same time, you must not overuse it.

Why the 30% Rule of Thumb Could Be Costing You

More often than not, the standard rule of thumb on the use of credit cards stands in the way of the account holder getting the best loan terms. Banks and others may advise you to keep revolving your debt as long as it is below 30% of your credit score. This is so that the credit utilization rate does not prove to be detrimental to your credit score.

However, financial experts warn that in some cases, anything that is above 5% will be bad for the credit score. This happens because when your revolving debt rises, your credit score starts falling. This happens much before you even reach 30% of the credit limit.

To Sum Up

Still confused? Don't worry. You will get the hang of it as you gain more experience in the world of credit.

It is slightly tricky to stay in the optimum utilization zone. Make sure that you keep yourself updated with your credit standing.

 

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