A:

Both your balance-to-limit ratio and your debt-to-income ratio are very important figures when you apply for and obtain credit, but they describe distinctly different financial realities. Balance-to-limit ratio – sometimes referred to as debt-to-limit ratio or credit utilization rate – is equal to the percentage of your present total realized debt relative to your total combined credit limit. A higher balance-to-limit ratio means that you are closer to borrowing capacity, and lenders may take that as a sign that you are having difficulty meeting your debt obligations. Debt-to-income ratio, as the name suggests, is the ratio between how much debt you presently have over how much money you currently make. Debt-to-income does not directly affect your credit score, but it does impact your ability to borrow additional money.

There are also different thresholds for what is considered a healthy ratio between the two figures. The credit bureau Experian recommends that you not have a balance-to-limit ratio higher than 30%. It is better to have a lower credit utilization rate than a higher one. Debt-to-income ratios are typically considered acceptable between 36% and 43% and under.

Your balance-to-income ratio is only calculated using credit card debt. Mortgages, auto loans and student loans are not factored into your ratio.

There are two ways to improve your balance-to-limit ratio: acquire more credit or pay off existing balances. Applying for credit usually involves a credit check – which hurts your credit score – and carries the hazard of being able to borrow more than you should. Pay off existing debts to improve your ratio. Your balance-to-limit ratio is listed on your consumer credit report, so you can request a copy of your own report if you are uncertain about where you stand.

Debt-to-income can be calculated by any lender when you apply for credit. It is used in conjunction with your credit score to determine your ability to repay a new loan. However, FICO does not take income into consideration when calculating your score, so you cannot raise your credit score by improving your debt-to-income ratio.

Payments that are factored into debt-to-income calculations include rent or mortgage payments (including taxes), minimum credit card payments, minimum car or student loan payments, child support and alimony obligations, minimum payments on other loans listed with credit bureaus and your total monthly take-home pay plus income from other sources.

Like any ratio, you can improve you debt-to-income by modifying either the numerator or the denominator. Paying down existing debts or increasing your income will both improve your debt-to-income ratio.

If you are attempting to improve either your debt-to-income ratio or your balance-to-limit ratio, prioritize which debts are most important to pay off first. Higher-interest loans should be attacked first. Set a target for what you want your ratio to be, and make a realistic budget that allows you to reach that target.

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