Spend Smart: How do you earn a good credit score?

Do you often get a call from your credit card company offering to expand your credit limit? Think before you accept that offer, as your card utilisation has an impact on your credit score.

Credit utilisation ratio, obtained by dividing the outstanding balance by the total credit card limit, tracks the extent of your card utilisation.

That is, if your credit card limit is ₹1 lakh and the outstanding balance is ₹30,000, your credit utilisation ratio is 30 per cent (₹30,000 divided by ₹1 lakh).

In case you have more than one credit card, the outstanding balances on all the cards are added and the total is divided by the sum of all credit card limits to arrive at the ratio.

Why should you care about this number? Rajiv Raj, co-founder and Director of CreditVidya says: “With a 30 per cent weightage, credit utilisation ratio is the second most important factor when computing the credit score.”

Is there an ideal ratio that will enhance your credit score? There is no fixed number, according to experts. Says CreditMantri co-founder and CEO Ranjit Punja: “There is no hard and fast rule on the ideal utilisation ratio. Keep it below 50 per cent to enhance your credit score.”

But CreditVidya’s Raj advises credit card users to be conservative and keep the ratio at less than 20 per cent to build a good credit score.

The ratio is calculated by the bank or the card issuer, and reported to the credit bureau every month. To compute the credit score the bureau takes an average of the last two years’ ratio. Higher weightage is given to more recent utilisation.

A good credit score has it uses. It can, for example, help in easy approval of your home loan.

To improve the credit score, maintaining a low utilisation ratio can be a vital. According to experts, a low utilisation ratio plays a significant role in rebuilding credit history as well.

So how can you keep your credit utilisation ratio low and thereby enhance your credit score?

“Pay your credit card bills in full and avoid closing credit cards where the balances are nil, or those that you have been using for a long time,” says Raj.

If you have just one card and use it extensively, chances are that you will end up having a higher utilisation. And this will have a negative impact on your score. It would be a good idea to get a new card and split your spending between the two cards, so as to keep your utilisation ratio low.

It is important to be conscious of your utilisation level and make an effort to keep it under check. “Higher utilisation of the credit limit can make repayment difficult,” cautions Raj.

“The bank or card issuer always wants your utilisation to be high so that they can earn money on the increased number of transactions. But higher utilisation increases the risk of missing the payment. This will pave the way for the card issuer to earn more interest out of it,” adds Punja of CreditMantri.

So what should you do if your card issuer offers to increase the limit on your credit card?

“If you already have two or three cards and the usage is less than 50 per cent, you can opt for a higher limit. But if the usage is more, it is better to get a new card than increase the limit on your existing card,” says Punja.

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