Credit utilization ratio is the term which is used in the context of credit cards; it refers to that percentage of credit card limit which the customer has utilized from the total limit of credit card. It can be better understood with the help of an example suppose you have 2 credit cards and on one card your credit limit is $10000 and other card your limit is $20000, then you total credit limit is $30000 and if you have utilized $15000 then credit utilization ratio will be 50 percent. Another way of understanding this concept is that suppose you have two kids and to each kid you give $10 daily and if after one month you ask them how much money is left and if one kid has $20 and second has $50 then naturally in the eyes of parents second kid has more creditworthiness or financial discipline, in the same way credit utilization ratio works in real or practical life.
Credit utilization ratio assumes importance while calculation of credit scores when a bank or financial institution is giving a fresh loan to the customer. A higher credit utilization ratio will be viewed as negative or will lower credit score because it implies that customer is using more credit out of his or her credit limit whereas a lower credit utilization ratio will result in improvement of credit score. Ideal credit utilization ratio is between 25 to 35 percent and anything higher than this may be considered as red signal by the agency giving credit rating score.
Credit utilization ratio calculation can be tricky because if customer wants to lower his or her credit utilization ratio he or she will take new credit card without utilizing the credit limit which will result in lowering of ratio and on the contrary if the customer close his or her credit card then it will result in increase in the credit utilization ratio.
A higher credit utilization ratio is not a bad thing in itself, however if one wants to take fresh loan then one should first lower this ratio by either paying his or her dues to credit card companies or taking new credit card thereby increasing the credit limit and then apply for the loan as credit utilization ratio carries substantial weight in credit score computation.