What is the Credit Utilisation Ratio and How to Calculate it?

ByRamesh Kumar
is-0-a-good-credit-utilization-ratio

Before approving a home loan application of a borrower, every lending financial institution checks the credit score. This score acts as a parameter determining the eligibility of an applicant for a loan application. An important parameter that helps determine the CIBIL score is the credit utilisation ratio.

What is the credit utilisation ratio?

Credit utilisation ratio is one of the most important factors that affect a borrower’s credit or CIBIL score. It is the percentage of credit that a borrower utilises from its available total revolving credit.

This ratio is used by all credit bureaus and lending financial institutions to estimate the credit score of home loan borrowers. However, it is advisable to keep this ratio on the lower side, as a higher ratio can result in a poor CIBIL score.

What is the credit utilisation ratio calculation formula?

The formula that financial institutions and credit bureau uses to calculate credit utilisation ratio is as follows:

Credit utilisation ratio = (Total amount outstanding / Total credit available) x 100

How to calculate credit utilisation ratio?

After learning the formula, it will be easier to learn the calculation of a credit utilisation ratio by providing a relevant example, which is as follows:

A borrower owns 4 credit cards, A, B, C, and D, having a total credit limit of Rs.3 lakh. There is also an outstanding balance on each of the cards which are:

A = Rs.60000

B = Rs.40000

C = Rs.3000

D = Rs.2000

Therefore,

Total outstanding amount 

= sum of all outstanding credit

= Rs. (60000 + 40000 + 3000 + 2000)

= Rs. 105000

Now,

Credit utilisation ratio

= (105000 / 300000) x 100 %

= 35% 

Hence, the borrower’s credit utilisation ratio is 35%. In addition, this ratio for each credit card can be estimated using the same method.

What is a good credit utilisation ratio?

According to financial institutions and credit bureaus, the best credit utilisation ratio must be less than 30% of the total credit limit. 

It is advisable to always maintain a lower credit utilisation ratio to avail home loans easily without the application getting rejected. This also indicates that the borrower is able to plan and manage credit goals properly. On the other hand, a higher ratio shows that the borrower is spending more and is unable to plan and manage finances properly.

What is the impact of credit utilisation ratio on credit scores?

The impact of credit utilisation ratio on credit score is severe if the borrower constantly uses it up to the given limit. This states that they are credit hungry, resulting in a drop in credit scores. Hence, it is important to manage credit goals properly and pay debts on time to increase CIBIL score. Moreover, it will help in quick approval of home loan applications.

What other factors affect credit score?

The factors that affect the CIBIL score of a borrower other than credit utilisation ratio are as follows:

  • Large outstanding debts

The most common factor affecting the credit score of a borrower is the existence of large outstanding debts. It usually occurs due to the application of multiple loans at a time. Hence, it is advisable to avoid doing so and simultaneously manage finances accordingly. This will also help a borrower repay EMIs on time.

  • Poor repayment history

Another usual factor that lending financial institutes check to estimate CIBIL score is the repayment history. If this history shows delayed or defaulted repayments it will lower the credit score. Hence, it is advisable to manage finances properly and repay loans accordingly.

  • Poor credit mix

A poor mix of loans can affect the credit score negatively. Therefore, it is always ideal to take a mixture of both secured and unsecured loans and repay them on time, to boost the credit score.

Hence, it is clearly understood that the lower the credit utilisation ratio, higher is the credit score and the better the chances of availability of a home loan. For this, an applicant should clear off all the existing outstanding debts and then apply for loans.