Is Zero Credit Utilisation Hurting Your Credit Score?

There is a widespread belief in credit scoring that maintaining zero credit utilisation is the ultimate recipe for a stellar credit score. It's an appealing concept indicating financial responsibility and a clean slate.

However, before jumping to conclusions, it's crucial to delve deeper into the intricate relationship between credit utilisation and your credit score. To fully comprehend and appreciate the impact of the credit utilisation ratio on your credit score, it is important to understand what it entails, how it operates, and how it affects your credit score.

Understanding the complex interplay between credit utilisation and credit scores is essential in today's financial landscape. The decisions you make regarding your credit can have far-reaching consequences on your ability to secure loans, mortgages, and favourable interest rates.

In this informative blog, we will embark on a comprehensive exploration of the impact of credit utilisation on your credit score. We'll shed light on the often-misunderstood notion of zero credit utilisation and address the question: "Is it good to have zero credit utilisation?"

What is Credit Utilisation Ratio?

The Credit Utilisation Ratio, also known as the Debt-to-Credit Ratio, is a measure that compares the amount of credit you have used to the total credit available to you. It is expressed as a percentage and is an important factor in calculating your credit score.

Lenders and credit scoring models consider a lower credit utilisation ratio favourable, indicating responsible credit management and a lower risk of defaulting on payments. On the other hand, a high credit utilisation ratio suggests that you are heavily reliant on credit and may face financial difficulties, increasing the risk of late or missed payments.

As you accumulate expenses on your credit cards in addition to any existing outstanding loans, your credit utilisation ratio increases correspondingly. And while a one-off higher utilisation rate does not impact your credit score, consistently high credit utilisation harms your credit score.

To calculate your credit utilisation ratio, divide your total credit card balances or outstanding loan amounts by your available credit limit. Then you can put these values in a simple formula to get your credit utilisation ratio.

Credit Utilisation Ratio= (Total Outstanding Amount)/(Total Available Credit) ×100

For example, if you have a total credit limit of INR 2,00,000 and the amount of your outstanding balances is INR 88,000, your credit utilisation ratio would be:

88000/200000 ×100 =44%

Responsible credit card usage plays a vital role in maintaining a healthy credit score and establishing long-term financial credibility.

How Credit Utilisation Affects Your Credit Score

Keeping your credit card utilisation low is one of the simplest ways to maintain a positive credit profile and stay financially healthy. Numerous studies have indicated that individuals tend to spend more when using credit cards as opposed to debit cards or cash.

It is common for people to struggle with the temptation to maximise their credit cards and utilise their entire credit limit, especially when they believe they are getting a favourable deal or encountering a bargain. However, such excessive credit card usage not only leads to a recurring cycle of unnecessary shopping and debt but also has negative repercussions on both credit scores and creditworthiness.

Your credit utilisation ratio provides lenders with an indication of how prudently you utilise your available credit limit and manage your debts. The credit card utilisation impact on credit score is significant, It is crucial to assess your creditworthiness, and it significantly affects your credit score calculation. A high credit utilisation ratio reflects a credit-hungry mindset, which lenders perceive as financially risky behaviour. A balanced credit card utilisation rate not only reflects financial discipline but also boosts your credibility in the eyes of lenders. High utilisation suggests a potential inability to manage finances effectively, leading to a lower credit score.

On the other hand, maintaining a low credit utilisation ratio, ideally around 30-40% is generally seen as positive for your credit score. It indicates responsible credit management and the ability to live within your means.

Credit utilisation is calculated both on an individual account basis and as an overall ratio of all your credit accounts. It's recommended to keep the utilisation low on separate accounts as well as maintain a low overall credit utilisation ratio.

The impact of credit utilisation on your credit score can vary based on other factors such as payment history, length of credit history, and mix of credit accounts. However, it is generally advisable to keep your credit utilisation as low as possible to maintain a good credit score.

What is a Good Credit Utilisation Ratio?

Now that you have grasped the concept of a credit utilisation ratio, its calculation, and its impact on your credit score, the subsequent query arises: how to maintain a favourable credit utilisation ratio?

A commonly recommended guideline is to maintain your credit utilisation below 30 per cent. The ideal credit card utilisation is typically, 30- 40% as recommended by financial experts and credit bureaus. This guideline applies to both individual credit cards and your overall credit utilisation ratio. Going above this range can lower your credit score, as lenders may perceive it as a sign of excessive reliance on credit. Experts recommend reviewing your credit card utilisation across all accounts monthly to ensure it stays within the ideal range.

However, it's important to note that occasionally exceeding this range on a specific card does not automatically result in negative consequences for your credit score. Irregular and high credit card utilisation can make your credit profile seem unstable, thereby affecting your eligibility for future loans. The impact on your credit score becomes more significant if consistently high utilisation is observed over a certain period, suggesting a recurring pattern of credit dependence.

Maintaining the ideal credit card utilisation across individual accounts can significantly boost your chances of securing favourable credit terms.

Is it Good to Have Zero Credit Utilisation?

Zero credit utilisation might appear to be a smart financial move, but it can limit your ability to build a strong credit profile over time. Lenders and credit bureaus consider low credit utilisation ratios to be good indicators of the borrower being in control of their finances and not spending recklessly beyond their means.

However, achieving a credit utilisation ratio of zero is not necessarily beneficial, as it can indicate that you are not actively using credit. Contrary to popular belief, this may not be the best strategy to improve your credit score and establish your creditworthiness to potential lenders.

Some credit scoring models may even interpret a zero ratio as a lack of credit history, which can potentially result in a lower credit score. While zero credit utilisation signals that you are not relying on credit, it may also suggest a lack of credit activity to scoring models.

Some of the reasons it may not be beneficial to have a zero-credit utilisation ratio are:

With zero credit utilisation, lenders and credit bureaus have access to limited or no credit history, which leads to difficulties in credit history assessment and evaluation of your creditworthiness.
Using your credit cards responsibly allows you to build your credit history, demonstrate your creditworthiness, and improve your credit score. Focusing on the zero-credit utilisation strategy means you miss the opportunity to demonstrate responsible credit use.

Additionally, having zero credit utilisation can also have other drawbacks, such as:

Limited access to credit options during emergencies, as lenders may hesitate to offer credit without recent credit activity and history.
Negative impact on credit applications due to a lack of demonstrated credit history and track record of responsible credit usage.
Difficulty building a strong credit profile and maintaining financial health for future goals.
Relying solely on zero credit utilisation could hamper your credit-building journey, especially if lenders require a proven credit repayment history.

So, it is evident that relying on zero credit utilisation is not a prudent strategy when aiming to build a strong credit profile, establish creditworthiness, and enhance your credit score. But if you want to sustain a low credit utilisation ratio, here are a few habits to maintain a healthy credit score:

Clear any high outstanding amounts from your credit cards to lower your credit utilisation.
Make more frequent credit card payments. For instance, consider paying off your credit card balance every 10 days instead of waiting for the monthly statement. This practice replenishes your credit limit regularly, lowering visible credit utilisation rates.
Use multiple credit cards for different transactions instead of relying on a single card. This helps maintain a lower credit utilisation rate across all cards, avoiding high utilisation on one card and low utilisation on others.
Do not close old credit cards, but keep them active with small purchases. Closing old credit cards will reduce your total available credit and increase your credit utilisation ratio.

By balancing your credit card usage and timely repayments, you can build a strong credit history that reflects well in your credit profile.

Conclusion

In conclusion, while it may seem counterintuitive, having zero credit utilisation is not necessarily beneficial for your credit score. While maintaining a low credit utilisation ratio is generally recommended, avoiding credit utilisation can hurt your creditworthiness.

Lenders and credit scoring models consider a demonstrated ability to manage credit a positive factor. Therefore, it is advisable to use credit wisely, keeping the utilisation ratio low but not at zero. Understanding the credit card utilisation impact on credit score helps consumers take proactive measures to maintain financial stability.

It’s better to aim for a low but non-zero usage rate rather than complete zero credit utilisation for a well-rounded credit profile. By understanding the role of credit utilisation and practising responsible credit management, you can build a stronger credit profile and improve your overall credit score.