What is the Debt-To-Limit Ratio
The debt-to-limit ratio is the ratio of a consumer's total credit card balances versus total credit card limits, expressed as a percentage. It is a key component when calculating an individual's FICO score, second only to payment history as an indicator of credit risk. The debt-to-limit ratio has many other names, including the balance-to-limit ratio, credit utilization ratio or debt-to-credit ratio.
BREAKING DOWN Debt-To-Limit Ratio
The debt-to-limit ratio generally refers to credit card debt and limits but can also include lines of credit and other revolving debt. The calculation is your credit card balances divided by the total credit card limits. A debt ratio below 30% is considered "good" by FICO and will help improve one's credit score.
Debt-to-Limit Ratio and Credit Scores
Debt-to-limit ratios can be kept to 30% or below by not carrying balances, or by securing a credit limit increase. Higher credit scores tend to go hand-in-hand with lower debt-to-limit ratios. A lower ratio is better, since a high ratio suggests the borrower is utilizing a lot of their available credit, potentially facing financial problems if their cash flow becomes strained. The nearer the ratio is to 100%, the closer the consumer is to maxing out his or her available credit.
The debt-to-limit ratio accounts for 30% of your FICO Score, behind only payment history, which makes up 35%. Other components include the type of debt you have and number of new credit accounts, each making up 10%, and the length your accounts have been open makes up 15%.
Some experts suggest that since the debt-to-limit ratio is calculated based on the balance at the statement closing date, 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 lower debt-to-limit ratio.
Debt-to-Limit Ratio Example
For example, assume Bob has three credit cards. Credit card A has a balance of $1,000, credit card B has a $500 balance and credit card C has a $2,500 balance. The max credit limit for card A is $1,500, card B's is $1,000 and card C's is $5,500. Bob's debt-to-limit ratio is 50%. If Bob's sister Barb has a single credit card with a $6,000 balance and a credit limit of $24,000, her debt-to-limit ratio is 25%. Barb’s ratio would therefore have a more favorable impact on her credit score than Bob’s ratio would have on his score.