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CreditSmart University: Debt To Credit Ratio Meaning

All That You Need To Know About Debt To Credit Ratio

Many factors affect your CIBIL score, one of them being your debt to credit ratio, which tells the amount of available credit you are using.

Consider this example: You own a card which has a maximum credit limit of INR 100,000. Your balance at the end of the month is INR 90,000. In other words, the debt to credit ratio in your case is:

90,000 ÷ 100,000 = 0.90 (that is, 90 percent utilization of the total available credit)

Of course, this is a simple example and in real case scenarios the numbers could be more complicated. However, the formula (credit used divided by the total credit available) for calculating the debt to credit ratio is the same. The debt to credit ratio is also called credit utilization ratio.

Credit Bureau Interprets Credit Utilization on Two Parameters

One is credit utilization of a particular card. Another is total credit utilization.

Both are calculated using the same formula. Continuing with the above example, you’ve debt to credit ratio of 0.90 on your one card.

Now, let’s suppose you have another card with the same maximum limit and an outstanding balance of INR 5,000. So for this credit card, the credit to debt ratio will be 0.05 (5,000 divided by 100,000).

And your total credit to debt ratio will be:

95,000 (sum total of balance on your two cards) ÷ 200,000 (total credit available to you) = 0.475

How much credit utilization is too much?

How CIBIL interprets credit utilization is something that only CIBIL can tell. What we know is that it doesn’t look favorably at higher credit utilization. Most credit repair experts believe credit utilization above 50 percent can hurt your score. In other words, you should try to keep your total credit utilization as well as credit utilization of any card you hold under 50 percent.

How lenders read high credit utilization?

They read it as high risk. From a lender’s perspective, anyone with high credit utilization is in all probability dependent on credit to meet his financial requirements. Such a person is more likely to default, especially in case of an unfortunate incident, like loss of job. Even otherwise, giving loan to a person who’s already using its credit limit to the hilt may overstrain his budget and result in delayed payments.

How you can prevent high credit utilization?

Many times high credit utilization is not because of financial indiscipline but rather because of lack of awareness. Consumers, because of lack of knowledge about credit utilization and its impact on their credit score, don’t pay attention to how they use their credit cards and believe, as long as they are paying the bills on time, it doesn’t matter what their credit utilization is.

You can manage your credit utilization by:

  • Using your different cards evenly – As we saw above, the credit utilization on one card was extremely high at 90 percent and on the other it was extremely low at 5 percent. While in this case the total credit utilization is not too high at 47.5 percent, the individual CIBIL score can take a hit on count of super high debt to credit ratio on one credit card.
  • Ask the bank to increase the credit limit – Over the years your income will increase, so will your expenses. If the credit limit on your credit card is the same as what it was 5 years ago, you are very much likely to report high credit utilization. Why no submit a request to the bank to increase the credit limit on your card, instead? In most such cases, banks willingly increase the maximum credit amount.
  • Apply for a new card – It is possible that your bank may reject your request even after you submit a proof of your new salary. This can happen if in past you’ve been often late in making payments. Try your luck with other banks if this is the case.

In case you are unable to effect an increase in the credit limit,  for time being pay some of your bills in cash, so that credit utilization ratio isn’t too high. Also remember to pay your bills on time. These two tips will help improve your score gradually, and once that happens, you can then reapply for an increment of credit limit or a new credit card.

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