Why does your credit utilisation ratio have such a big impact on your CIBIL score?

What is the credit utilisation ratio?

The credit utilisation ratio measures the amount of credit an individual utilises from the credit limit available to them. For example, an individual has a credit card with a limit of Rs. 1 lakh and has utilised the card for Rs. 20,000. In this case, the individual’s credit utilisation ratio is 20%.

Any individual may have multiple credit cards. In that case, the overall credit utilisation ratio, including all credit cards, will be considered.

Let us see how to calculate the overall credit utilisation ratio. Suppose Akash has 3 credit cards with the following details.

The credit utilisation ratio is calculated as follows:

(Limit utilised / Credit limit) * 100

= (1,00,000 / 4,00,000) * 100

= 0.25 * 100

= 25%

Thus, Akash’s credit utilisation ratio is 25%.

How does the credit utilisation ratio impact your CIBIL score?

In the above section, we calculated Akash’s credit utilisation ratio at 25%. How should you read this ratio to analyse whether it is high, low, or okay? Usually, banks consider a credit utilisation ratio of 30% or lower as good. The general trend is that the lower the credit utilisation ratio, the better, other things being constant.

If your credit utilisation ratio is 30% or lower, it contributes positively towards increasing your CIBIL score. However, if the credit utilisation ratio is more than 30%, it may contribute adversely towards decreasing your CIBIL score. Hence, always keep a watch on your overall credit utilisation ratio, and keep it at 30% or lower.

A higher credit utilisation ratio indicates that you are credit-hungry and not able to manage your finances properly. A higher credit utilisation ratio may impact your ability to get further credit from banks in the form of loans, credit cards, etc. If your credit utilisation ratio is higher than 30%, you should take steps to reduce it to 30% or below.

It is important to note that the credit utilisation ratio is only one of the parameters for calculating your CIBIL score. Some of the other parameters include the history of timely payments, credit mix (secured and unsecured loans), age or duration of card(s) and loan(s), number of credit accounts that you hold, the number of credit applications and the frequency at which you make them, etc. So, even if your credit utilisation ratio is 30% or less, but the other parameters are beyond limits, it may still impact your CIBIL score adversely.

How to lower your credit utilisation ratio to improve your CIBIL score?

If your credit utilisation ratio is more than 30%, here are some suggestions to lower it.

a) Accept credit limit enhancement offer(s)

Depending on your credit card usage and repayment track record, from time to time, the bank will send you credit limit enhancement offers on your credit card. In a credit limit enhancement offer, the bank proposes to increase your existing credit limit on the credit card.

Whenever you get a credit limit enhancement offer, accept it as it will increase your overall credit limit. With an increased credit limit and the same amount of monthly credit card usage, the credit utilisation ratio will go down.

For example, suppose you have a credit card with a limit of Rs. 1,00,000 and use it for Rs. 40,000 every month. In this case, your credit utilisation ratio is 40%, which is on the higher side. The bank gives you a credit limit enhancement offer to increase the credit limit to Rs. 2,00,000. You can accept the credit limit enhancement offer. With an enhanced credit limit of Rs. 2,00,000 and the same monthly credit card usage of Rs. 40,000, the credit utilisation ratio will fall from 40% to 20%, which is a good improvement.

b) If your income has increased, approach the bank for credit limit enhancement

Sometimes, the bank may not send a credit limit enhancement offer for a long time, and your income may have increased. In such a scenario, you may send your revised income documents to the bank and ask for a credit limit enhancement on your credit card. The bank may review your income documents, and if found eligible, the bank may send you a credit limit enhancement offer.

When you accept the credit limit enhancement offer and maintain the same monthly credit card usage, your credit utilisation ratio will fall.

c) Accept free lifetime credit card(s)

Some banks offer some credit cards on a lifetime-free basis. You may apply for such card(s) to increase your overall credit limit. When your overall credit limit increases and your monthly credit card usage remains the same, your credit utilisation ratio will fall. With lifetime free credit cards, there is no joining and annual fee. Hence, there is no harm in keeping such cards if they can help you increase your overall credit limit and lower your credit utilisation ratio.

d) Don’t close unused credit cards

You may have some credit cards that you may no longer use. You may be thinking of closing them. However, if you do that, your overall credit limit will decrease, and if the monthly credit card usage is the same, the credit utilisation ratio will increase.

So, don’t close unused credit cards if you want to maintain the same overall credit limit and credit utilisation ratio. An important point to note is that credit card ageing is also one of the parameters contributing to improving your overall CIBIL score.

Keep a low credit utilisation ratio to maintain or increase your CIBIL score

We have discussed what should be an ideal credit utilisation ratio and some of the ways in which you can lower it. A lower credit utilisation ratio indicates that you manage your finances well within your means. Apart from maintaining a credit utilisation ratio of 30% or lower, work on the other parameters that are considered for calculating your CIBIL score. All these steps will help in increasing your CIBIL score. The higher the CIBIL score, the better the chances of getting more credit at lower interest rates and other favourable terms.

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Published: 07 Jun 2024, 03:49 PM IST