Abhishek
has two credit cards which he uses frequently; almost all his
transactions are done on credit cards. His cards are always maxed out
but he manages to always pay his dues on time. Since he has always
paid on time and never faltered on his payments Abhishek assumed that
this could never be a problem, till he required a loan which was
rejected due to a low score.
Do
you also like Abhishek feel that as long as you are paying your dues
on time, how much of the card limit you utilize is not important? If
yes then you need to reconsider your spending pattern and go through
the discussion below.
Impact
of credit card usage on credit rating:
All
credit cards
have a sanctioned limit; this is the limit till which you can use
your card without having to pay your old dues. As long as the car
holder spends within the sanctioned limit and pay his dues on time
he/she does not have to pay any extra charges to the card company.
This prompts the card holder to assume that since the card company is
not collecting any extra charges or fines, the proportion of card
limit they use has no relevance whatsoever. While this may be true
from the perspective of card issuer; card usage impacts the credit
rating of the user.
Let’s
see how Abhishek uses his cards. He has two cards, the first with a
limit of Rs. 100,000 and the second with a limit of Rs. 75,000. His
average usage on the first card is around Rs. 80,000 to 85,000 and on
the second card around Rs. 60,000 to 65,0000. This means that he uses
almost 80% to 85% of his sanctioned limit on each card and his
overall card usage of both cards combined is also 80% to 85%.
As
is evident from the chart alongside credit utilization has a big
impact on the overall score calculation. In fact it is the second
most important factor in the overall score calculation after
repayment history which has a 35% weightage in the overall score
calculation.
So
when someone overuses their credit card regularly and has a tendency
to max on the cards then it could lead to a low
CIBIL score even if they do manage to pay on time. Credit
rating companies look at card utilization ratio in order to assess
credit discipline and also judge the risk level associated with an
individual.
High
credit utilization is an indicator of overdependence on credit; it
also means that there is higher risk of default associated with the
person in case he/she losses the running source of income. High
credit utilization also indicates poor financial planning. Ideally
the credit utilization should be less than 35% to ensure a good
credit score.
How
to deal with overuse of credit card?
In
case your cards are also maxed out then it is time to evaluate your
card usage and figure out a way to reduce the card utilization ratio.
The most obvious way to deal with a situation like this is to reduce
your card usage and use other options for financial transactions. You
may find it difficult to do so for two three cycles as you will need
to pay the dues which can reduce your liquidity.
Another
option is to get a bigger card limit if you are eligible for it. A
bigger card limit will reduce the credit utilization ratio without
the need to reduce the card usage. One can also opt for another card
so that the overall card limit increases and the card usage is spread
across all cards.
However
it is important to remember that a new card and increased card limit
should not be an excuse to increase the card usage further as it
could lead you to a situation where you fall into a debt trap or find
it difficult to repay your dues at the end of the cycle.