Credit utilization rate can be defined as a calculation that is done to calculate the individuals total debt balance to the total available credit with the individual.
Calculation of Credit Utilization Rate
Credit utilization rate can also be termed as the credit utilization ratio and can be defined as the ratio between the available debt and the available credit of an individual to pay that debt. The formula of debt utilization rate can be shown as under:-
Credit Utilization Rate = Total Debt Balance/ Total Available Credit
In order to understand the concept of credit utilization rate let’s assume that a person has got three credit cards. One has a credit limit of $500, another has a credit limit of $1,000 and the third has a credit limit of $2,000. Let’s also assume you carry a debt balance on all three cards. The three card balances combine to $1,000.
Total Debt Balance = $1,000
Total Available Credit = $500 + $1,000 + $2,000 = $3,500
By plugging these two factors into the formula, we can find the credit utilization ratio:
Credit Utilization Rate = ($1,000) / ($3,500) = .2857 = 28.57%
In this case, your credit utilization rate is 28.57%. Looked at another way, this would mean that you are using 28.57% of your available credit limit.
Why Credit Utilization rate is important
Credit utilization rate is important to find out about the financial health of a business entity or an individual as it describes the amount of debt carried by the individual and the available credit to pay this debt. If the credit rate is lower more the investor will trust on the borrower as it looks favorable to them to lend money to that borrower as he has adequate credit to repay the debt.
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