DEFINITION of 'Debt-To-Limit Ratio'

The ratio of total balances on a consumer’s credit cards to the total credit limits on these cards, expressed as a percentage. The debt-to-limit ratio is a key component when calculating credit scores, and is second only to payment history as an indicator of credit risk. The lower the ratio, the better, since a high ratio may suggest that the borrower is facing financial problems. The nearer the ratio is to 100%, the closer the consumer is to maxing out his or her credit cards and becoming trapped in a debt spiral due to the high interest rates charged by most cards.

Also known as the balance-to-limit ratio or utilization rate.

BREAKING DOWN 'Debt-To-Limit Ratio'

For example, assume Bob has three credit cards with a total balance of $4,000 and an aggregate credit limit of $8,000. Bob’s debt-to-limit ratio is therefore 50%. What if his sister Barb has four credit cards with a total balance of $6,000 and an aggregate credit limit of $25,000? Barb’s debt-to-limit ratio is 24%. Barb’s ratio would therefore have a more favorable impact on her credit score than Bob’s ratio would have on his score.

VantageScore Solutions suggests that the debt-to-limit ratio should ideally be below 30%. In fact, consumers with the highest FICO credit scores have an average debt-to-limit number of only 7%.

In order to ensure that the ratio does not exceed 30%, either the balance carried on credit cards has to be controlled, or the credit limit has to be increased. The latter option may not be available to indebted consumers who already have a significant amount of credit card debt.

Some experts suggest that since the debt-to-limit ratio is calculated based on the closing date balances reported to credit bureaus, consumers should try and pay off balances in full or part before the credit card statements are generated. This will ensure that the credit bureaus record zero or low outstanding balances, which will result in a low debt-to-limit ratio.

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