Ever wondered what goes into a lender’s decision when you apply for a loan? It’s not just about your income. Your credit utilisation ratio, a key factor in your credit score, plays a major role.
In this blog, we’ll unpack what a credit utilisation ratio is, how it’s calculated, and why it matters for securing that loan you need.
We’ll also explore tips for keeping your ratio in check and boosting your chances of loan approval. So, buckle up and get ready to unlock the secrets of this critical financial metric!
What is a Credit Utilisation Ratio?
Credit utilisation ratio is a metric expressed as a percentage that reflects how much of your available credit you’re currently using. It simply shows lenders how responsibly you manage your credit lines.
Imagine your credit limit is like a giant water tank representing your total borrowing power. The credit balance is the amount of water currently in the tank. The credit utilisation ratio tells lenders how full the tank is as a percentage.
A lower percentage indicates you’re using your credit responsibly, leaving plenty of room in the tank. Conversely, a higher percentage suggests you’re nearing your limit, which might raise red flags for lenders.
How is the Credit Utilisation Ratio Calculated?
The credit utilisation ratio is calculated using a simple formula that breaks down to the percentage of used credit divided by your total credit limit.
Credit Limit vs. Credit Balance
Before diving into the calculation of credit utilisation ratio, let’s establish two key terms: credit limit and credit balance. These are vital in calculating your ratio and understanding your overall credit health.
- Credit Limit: This is the maximum amount of credit you can borrow on a revolving credit account, like a credit card. Think of it as your spending ceiling set by the issuer based on your creditworthiness.
- Credit Balance: This is the current amount of money you owe on your revolving credit account. It’s the ever-changing total that fluctuates as you make purchases and payments.
Now that we’ve defined these terms, we can introduce how to calculate credit utilisation ratio
Here’s a step-by-step breakdown:
- Gather Your Numbers: You’ll need the total balance of all your revolving credit accounts (credit cards, lines of credit) for a specific statement period, all in AED. Additionally, find out the credit limit for each account in AED.
- Sum Up Your Balances and Limits: Add up the credit card balances from all your accounts to get your total credit card debt in AED. Likewise, add up the credit limits for each card to find your total credit limit in AED.
- Apply the Formula: Divide your total credit card debt (Step 2) by your total credit limit (Step 2). Multiply the result by 100 to express it as a percentage.
Formula: Credit utilisation Ratio (%) = (Total Credit Card Balance (AED) / Total Credit Limit (AED)) x 100
Example Calculation
Let’s say you have two credit cards in the UAE:
- Card A: Balance = AED 500, Credit Limit = AED 1,000
- Card B: Balance = AED 200, Credit Limit = AED 500
Following the steps above:
- Total Credit Card Balance = AED 500 (Card A) + AED 200 (Card B) = AED 700
- Total Credit Limit = AED 1,000 (Card A) + AED 500 (Card B) = AED 1,500
- Credit utilisation Ratio = (AED 700 / AED 1,500) x 100 = 46.67%
Therefore, in this example, your credit utilisation ratio is approximately 46.67%. This indicates you’re using almost half of your total credit limit.
Why Does Credit Utilisation Ratio Matter for Loans?
Your credit utilisation ratio plays a critical role in your loan approval chances. Let’s delve into why it holds so much weight for lenders:
Impact on Credit Score
Your credit utilisation ratio is a major factor influencing your credit score, often accounting for 30% or more. A higher ratio (meaning you’re using a larger portion of your available credit) typically translates to a lower credit score. Conversely, a lower ratio reflects responsible credit management and can boost your score.
Lender’s Viewpoint
Lenders view your credit utilisation ratio as a window into your ability to manage credit responsibly. A low ratio indicates you’re not living paycheck to paycheck and have room to take on additional debt without overextending yourself. This makes you a more attractive borrower in their eyes.
The Loan Approval Connection
A lower credit utilisation ratio directly translates to higher chances of loan approval. Lower ratios demonstrate your ability to handle credit responsibly, giving lenders more confidence that you’ll make your loan payments on time. Conversely, a high ratio might raise red flags, suggesting potential difficulty managing debt, and could lead to loan rejection.
Your credit utilisation ratio acts as a report card on your credit management skills. By keeping it low, you present a positive image to lenders and significantly increase your chances of securing the loan you need.
Tips for Keeping Your Credit Utilisation Ratio in Check
A healthy credit utilisation ratio is key to a good credit score and securing that desired loan. Here are some practical tips to keep your ratio under control:
Pay Down Credit Card Balances
This is the most straightforward approach. Consistently paying down your credit card balances reduces your overall credit card debt, directly lowering your utilisation ratio. Focus on paying more than the minimum amount due to make a significant impact.
Strategize Credit Card Usage
Avoid maxing out your credit cards. Aim to utilise only a small portion of your credit limit, ideally below 30%. Consider using multiple cards monthly and paying them off before the statement closes to keep your balances low.
Request Credit Limit Increases (Strategically)
While this might seem counterintuitive, requesting credit limit increases on your existing cards can actually improve your overall utilisation ratio, provided you don’t increase your spending. A higher credit limit expands your total available credit, even if your balance remains unchanged.
This lowers the percentage of credit you’re using and improves your ratio. However, only request increases if you’re confident you can maintain responsible spending habits within the new limits.
Bonus Section:
Common Credit utilisation Ratio Ranges:
- Excellent (< 30%)
- Good (30% – 50%)
- Fair (50% – 80%)
- Poor (> 80%)
Conclusion
Your credit utilisation ratio is a powerful metric that significantly impacts your credit score and loan approval chances. By understanding how it’s calculated and its importance to lenders, you can take control and leverage it to your advantage.
Remember, a lower credit utilisation ratio is your golden ticket. Here’s a quick recap:
- It reflects your credit management skills – a lower ratio showcases responsible credit usage.
- It directly impacts your credit score – maintaining a healthy ratio can boost your score.
- It influences loan approvals – lenders favour borrowers with lower ratios.
Check your credit report regularly (it’s free!) to monitor your credit utilisation ratio and overall credit health.
