Credit card utilisation is about the amount of credit that is used on the credit card. The credit card issuing company will allot a credit limit. The user can use the credit amount from the available credit. The credit utilisation rate is the ratio that gives an idea about the amount of credit used by the customer.
Credit utilisation ratio is the amount of revolving credit you are using divided by the total amount of available credit. For example, if a customer has a total AED 10,000 in credit on two credit cards and one card the balance is AED 5,000 the credit utilization rate will be 50%. This is half of the total credit which is used and it is the utilization ratio. The credit card utilization rate is calculated as below.
Credit Utilization rate= Total debt/Total available credit
How card utilization affects credit score?
Credit score models are created based on the card utilization rate. The credit card companies assess the card utilization of the user. The utilization rate can have an impact on the credit score. Card Utilization rate has a direct impact on score which can affect adversely. Credit card utilization rate should be below 30%. If the credit card utilization reaches 30% or more than that, it will have a negative on the credit card score.
Credit score of the user will be reduced adversely. If the credit card utilization is low it shows that you are using less available credit. It shows a positive sign and it looks that you are doing a good job managing your credit card when credit card utilization is less than 30%. Lesser credit card utilization shows that you are using your credit card genuinely and not overspending the limit on your credit card. It will have a positive impact on your credit score.
When you have a good credit score, the credit limit on your credit card increases and this is an advantage to the credit cardholder. It does not mean that you should not spend more using your credit card. It indicates that though you have a facility of spending more you are using less of your credit as your debts are low and you can manage your credit.
Credit score gets affected if you’re spending more than 30% of your credit. Banks and financial institutions are much particular about the spending because they assess the individual’s spending and estimate the repaying capacity of the individual.
If a cardholder spends more than 30% it is an alert and credit score drops. If credit score drops, banks hesitate and will not issue additional loans such as auto loans, mortgages, personal loans and additional credit cards.
Credit score and credit utilization are the figures which are generated based on the transactions of the cardholder. The credit information gets updated on credit reports which are based on billing cycles, auto debits, scheduled payments and other payments.
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High Credit Utilization
The main purpose of a credit card is that you will use the credit amount for your purpose and repay the money on time. If you are making high credit utilisation beyond your capacity then there are high likely chances that you will make a default on your payment.
Higher outstanding balances, making only the minimum balance payment and extending your payments will indicate that you’re in a difficult position to repay the credit. The higher the credit card utilisation higher the risk the lower the credit score that gets generated. It is a signal to the banks that the card user is at a risk stage that is the reason that high credit card utilization should be avoided.
What is a Good Credit Utilization Rate?
Financial experts suggest keeping the total credit utilization rate less than 30%. For example, if a cardholder has a credit limit of AED 10,000 then the credit card usage rotation should not increase AED 3,000. This is the rule of thumb that the credit card utilization rate should be below 30% of the credit card limit. Lenders worry if a cardholder exceeds the credit card limit. It is always advisable to spend below 30% of the credit limit.
Sometimes lenders look at the spending habits and increase the credit card limit. This does not happen with every cardholder; it depends on various factors such as a good track record, repayments history, good credit ratings and other factors.
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Tips to manage your credit utilization
There are various ways through which you can manage your credit utilization. The easiest and practical way is to keep track of your expenses and set up a balance alert. Apart from this, below are a few ways through which you can manage your credit utilization.
Divide your expenses
Do not pay all your bills and other payments from a single card. Spread your expenses evenly across different cards by following this way you can reduce the burden of not spending more than 30% of your credit limit.
Request for increase in credit limits
Ask your card issuer to increase your credit card limit. You can call the bank or apply through the mobile app. The bank will assess your account balance and payment history and sometimes ask for additional documentation. Suppose you have an increase in your income you can produce the document and the bank will increase the credit card limits. By requesting an increase in credit limit you may have a hard inquiry on the credit report which will affect your credit score.
Apply for another credit card
There is another way through which you can increase your credit limit that is by applying for an additional credit card. Remember, when you apply for an additional credit card you can reduce the credit utilization ratio but using a new credit card will not increase your credit score.
If you do not have control over your spendings then having more credit cards will tempt you to make more spendings and you will spend beyond repayment capacity. Applying for a new credit card will make a hard enquiry and your credit score may be affected so decide meticulously.
Do not close your credit cards
If you have multiple credit cards then maintain the total credit limit on the cards which you are not using. Do not close your credit cards. If you keep your credit card open the credit limit will be maintained and it will reduce the credit card limit utilization ratio.
Takeaway
The easiest way to handle your credit card utilization is to track your spendings. Check your credit card balances regularly and keep control of utilization. Card issuing companies provide balance alerts through email, text messages so that it becomes easier to maintain a good utilisation ratio. Check your credit score periodically and keep your credit utilization low as this can increase your credit limit and lenders can provide you higher loans with better interest rates.
About the author
Vinay Kumar Goguru is a finance professional with more than 8 years of diverse experience as a researcher, instructor and Industry work experience with both public and private entities. Prior to MyMoneySouq, he spent 6 years in Berkadia, It's a commercial mortgage banking company. He has a "Doctoral Degree in Commerce" and two master's degrees with a specialization in Finance, one as Master of Commerce and other as Master of Business Administration. He has written several articles on personal finance, published by different International journals. He loves traveling, reading and writing is his passion. He has a dream of writing a book on his favorite finance topics.
