If you have applied for a credit card, personal loan or any such financial product, I’m sure you know about how important a CIBIL credit score is. I’m not going to talk about how to improve your CIBIL credit score, as it is already addressed here. Instead, let’s talk in depth about that factor that affects your CIBIL credit score – credit utilization.
What is credit utilization & why is it important?
In India, CBIL credit scores have only been made mandatory recently. Earlier, it was easier to get a personal loan or other financial products from a lender or bank depending on whether you had connections with the bank manager. Of course, you had to provide details of your salary slip and other financial background, but mostly it was a subjective approval process. If bank manager thought you were good enough, he/she would grant the loan to you.
Not any more. With more standards being introduced to approval of financial products, CIBIL credit score has become the de-facto norm for approving or disapproving applicants. And credit utilization is the biggest factor that affects your CIBIL credit score.
Imagine this scenario. Your friend gave you Rs.1 lakh in loan. You can buy whatever you want. Your friend knows that you have only 25,000 monthly salary. Would your friend trust you more if you spent Rs.25,000 out of that 1 lakh or if you spent Rs.90,000?
Obviously, if you spent 25K right? Reason is that your friend knows that if you spend more than that you won’t be able to pay it back monthly to him.
Same thing with banks and lenders (or credit cards). When they approve you, they look at whether or not you’ve been spending within your limits with other credit cards you own. For example, if your credit card limit ifs Rs.50,000 and you’ve been spending Rs.40,000. This means that your spending is way higher than what you can actually pay back. If you spent only Rs.10,000 and you paid it back monthly, on time, your credit card company will trust you more.
This is why credit utilization is important for you and credit card companies. If you utilize your credit cards less and within your means, lenders are far likely to approve and trust you.
What is a good credit utilization ratio in India?
In India, it is advised that you keep your credit card utilization under 20-30% of your credit limit, every month. For example, if Rs.10,000 is your credit card limit, make sure you only spend for Rs.3,000 that month and pay it off promptly, when the bill is out.
Doing this consistently will increase your chances of improving your credit score and credit worthyness. (Source).
All the best!