EXPLAINED | Credit cards: How to calculate credit utilisation ratio and why it is important to keep it in check

Harnessing the full potential of credit cards offers perks from boosting credit ratings to reaping rewards and providing essential financial flexibility in emergencies. One of the most pivotal metrics in optimising credit card usage is the credit utilisation ratio.

What is credit utilisation rate or debt-to-credit ratio rate?

At its core, the credit utilisation ratio, occasionally referred to as the debt-to-credit ratio, quantifies the proportion of your accessible credit you are currently leveraging. Simply put, it is the relationship between your existing credit card balances and your collective credit limit. This ratio is a key component employed by credit referencing agencies to compute a borrower's credit score.

Why does debt-to-credit ratio increase when you max out a credit card?

Maxing out a credit card translates to using 100 per cent of the available credit limit on that card. This action inflates your debt-to-credit ratio, as the balance of your debt (what you owe) increases relative to your credit limit (your borrowing allowance). High utilisation hints at possible over-extension and potential difficulty managing additional credit, which can contribute to a downturn in your credit score.

What is credit score and why should you track it?

A credit score is a numerical summary of an individual's creditworthiness, utilised by lenders to evaluate the probability of the individual honouring their debt repayments promptly. It's shaped by numerous factors, encompassing payment history, current debt, length of credit history, variety of credit types, and recent credit applications. Notably, the credit utilisation ratio impacts approximately 30 per cent of your credit score, underscoring the importance of tracking it to uphold or enhance your credit rating.

Credit utilisation: A practical illustration

Let's consider an example for clarity: you have a single credit card with a limit of Rs 50,000, and you've run up a balance of Rs 20,000. This balance signifies the amount you have expended and not yet reimbursed.

The credit utilisation ratio is then computed by dividing your debt (Rs 20,000) by your credit limit (Rs 50,000):

20,000 / 50,000 = 0.4

This is then converted into a percentage:

0.4 * 100 = 40 per cent

In this case, your credit utilisation rate stands at 40 per cent, indicating you're utilising 40 per cent of your credit card's available limit.

Maintaining a low credit utilisation ratio is instrumental in enhancing your credit score. It signals to lenders that you are adept at managing credit responsibly without exhausting your credit cards, thereby reducing your borrowing risk profile.