Understanding your debt to credit ratio can help you increase your credit score and qualify for better interest rates and loan terms.
One of the primary factors that affect your credit score is your debt to credit ratio. Also known as your credit utilization ratio, this number compares your credit card balance to the amount of credit available to you. Lenders will look at your ratio to determine how risky it is to loan you money (the higher the percentage of available credit you are using the riskier you are to them). It also makes up about a third of your credit score, so unless you want your score sinking to the bottom of the ocean you’d better watch your debt to credit ratio carefully.
How is Debt to Credit Ratio Calculated?
Simple. All you need is your current credit card balances and the limit on each card. For each card, divide the current balance by the card’s limit and then multiply by 100.
For example, say you have a MasterCard with a $10,000 limit and your current balance is $3,000.
($3,000 / $10,000) X 100 = 30
In other words you are utilizing 30 percent of the credit available to you. You want to keep that number as low as possible. Most experts advise to keep it under 35% but if you can get it lower that’s even better. If your debt to credit ratio is already sky-high it’s time to stop charging and start paying down that debt until you get it down to a healthier level. This is especially true if you plan on taking out a new loan anytime in the near future.
Lenders will look at your debt to credit ratio for each of your credit cards individually as well as your overall ratio for all cards combined, so you’ll want to run this simple calculation for each of them to see how you stack up. And remember since credit utilization makes up 30% of your credit score, improving it is one of the most powerful ways to raise your credit score.