How to lower credit card utilization

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 of Rs.30,000 using the same credit card. The ratio between these two 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 ratio:

(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.

This calculation is based on your credit report, which is a detailed report of your credit history. A credit bureau (TransUnion, Equifax, Experian, etc.) prepares the credit report based on the information they get from your credit card issuing company. The calculation adheres to each card's billing cycle. While calculating your credit score, the credit bureaus consider your balance and credit limit as per the closing date mentioned in your credit card account statement.

How Does Credit Utilization Affect My Credit Score?

A lower credit utilization ratio is the best for maintaining a high credit score. It shows that you are keeping your expenditure within limits by using a small amount of credit. A high utilization rate indicates that you might not be able to pay your bills on time; therefore, a lower utilization rate - not exceeding 30% - is generally best for your credit score.

You must remember that the credit utilization ratio in each of your credit cards is taken into account, individually as well as collectively, to determine your credit score.

Reducing the Credit Utilization Rate

1. Pay Your Balance Early: The credit card issuing companies typically report your credit balance to the credit bureaus at the end of your billing cycle. You need not be worried about how much you are spending each month. If you pay a part, or preferably all, of your outstanding balance before the issuing companies report your credit balance, your credit utilization rate for the concerned cards will remain low.

2. Reduce Spending: If you notice that it's getting difficult for you to pay your credit card bills on time, you must stop making purchases with your credit cards. The new purchases made may increase your credit utilization ratio, which in turn will reduce your credit score. Use cash or a debit card at this juncture. As you clear off your existing debt, your credit utilization rate might drop and give a boost to your credit score.

3. Increase Your Credit Limit: A higher credit limit automatically brings down your credit utilization rate, provided that your expenditure or credit balance remains constant.
   You may call your credit card issuing company and request for an increase in the credit limit, or make an application online. However, increasing your credit limit isn't a piece of cake, and you might have to go through a rough road.
   There might be certain requirements that you need to qualify to get your credit limit increased. You might be required to have maintained your account for a specific period; your payment history might be scrutinized; and your credit score must be good enough for a raise in credit limit. At the same time, this request might be treated as a hard inquiry even if it goes unapproved. The inquiry itself could slightly reduce your credit score. You need to assess your chances carefully before taking a decision.

4. Open New Credit Card Accounts: If you get a new credit card, you will essentially increase your credit limit. If you keep a check on your expenditure, there is a good chance that your Credit Utilization ratio will come down. However, the application will be treated as a hard inquiry. In case the application is rejected, your credit score will be hampered.

5. Avoid Closing Old Credit Card Accounts: Well, if you ever get into a "Cleaning spree" and decide to close credit cards that are old and unused, stop yourself immediately. It might open up some free space in the card-holder section of your wallet, but at the same time it will cut down your total credit limit, thereby increasing your credit utilization ratio.

To Sum Up

Managing your credit utilization rate can be a simple way to help improve and maintain your credit score. Don't forget that there are two parts to the equation - your credit balance and your credit limit - and seek out ways to reduce and maintain a low ratio between the two. Various factors can bring down your credit score; don't let credit utilization ratio be one of them. A little effort in managing your credit utilization can significantly improve your credit score.

Need a little help with it? Try out mymoneykarma's Intelligent Finance Tool to get the best advice on managing credit utilization and boosting your credit score.