If you have a credit card, a number of people would have advised you to keep the credit utilization ratio under 30 percent. What is this ‘credit utilization ratio’ and why is it so important?
There are several factors that impact your credit health; one of these is the credit utilization ratio. It is the ratio of the total outstanding balances on your credit cards to the total credit limit. If you have no outstanding balance on any of your cards, your credit utilization rate will be zero. Credit utilization makes up a major portion of your credit report. A low credit utilization ratio positively affects your credit score and vice versa.
Exceeding 30 percent utilization mark on any of your credit cards can damage your credit score. So it is worth your time to understand how you can keep your credit utilization below the red mark.
1- Decrease Your Spending
The easiest and the most obvious way to lower your credit utilization ratio is by reducing your expenses. If you keep ringing new and heavy bills on your credit card every month, it will become quite difficult to lower your utilization rate. Cut down on your credit card expenses by shifting them to your debit card. Alternately, you can also shift the expenses to another credit card which has a comparatively lower utilization.
2- Increase your Credit Limit
Another way to reduce your credit utilization ratio is increasing the credit limit available to you. You can call your bank to request a limit increase on your credit card. Some banks also allow you to send a request directly by logging into your net banking portal. Whether you will be approved for limit increase or not is solely at the bank’s discretion. However, an important thing to note here is that when you send a limit increase request, a hard inquiry may be initiated on your profile which might dip your score initially but it will go up once you are approved.
Another way to increase the total credit limit is to apply for a new credit card. When you get a card for the sole purpose of getting more usable limit, it is better to go for a credit card with zero or low annual fee. Hard enquiry will be initiated in this case as well but if approved, it will be quite beneficial for your credit score.
3- Keep Track of Your Expenses
In order to avoid overusing the limit available to you, you should simply be aware of how much you are charging to each of your credit cards. Make it a habit to log in to your credit card account regularly to track your spending. If you find that you are about to breach the 30 percent limit on a card, switch to cash or to another card with lower utilization.
4- Pay off any Outstanding Balances
The more outstanding balance you carry on your card, higher will be your credit utilization ratio. So, if you are revolving outstanding balances from previous billing cycles, get rid of them first and then work on improving your credit score. Taking a personal loan might also be good if you are not able to pay off the entire balance in one go. When a huge outstanding balance is paid off, it will open up considerable limits on your card but its effects might not be visible on your credit report immediately. Once you have paid off the balances, wait for a month or two before you ring up new and big bills on these cards. Those who have a utilization ratio of more than 80 percent on any of their cards should start with paying accumulated outstanding balance and then making least expenses on the card for a few months.
5- Pay More than Once a Month
Banks are required to report your balances and payment activity to credit bureaus every month. But this date may or may not coincide with your billing date. For example, if the bank reports to the bureaus one week before your due date, then your credit report will show a higher utilization ratio, even if you pay on time. So, if you can afford to pay before the date on which the bank reports your balances, you can get the benefit of lower credit utilization.
6- Do not Close Unused Credit Cards
Even if you do not use a credit card anymore, you should not close it. Idle limit on your unused credit card will help in lowering your credit utilization rate and thus improve your credit score. Closing an old credit card will also shorten the life of your credit history which would again dip your credit score.
Keeping your credit utilization ratio below 30 percent on all credit cards will go a long way in improving your credit score. With an improved credit score, you can be eligible for loans and credit cards and will also be in a position to negotiate a better rate of interest on future credit.