Bet you didn’t know there was so much to talk about when it comes to credit reports! This time we’ll explain debt-to-credit ratios and what it says about your financial situation. A debt-to-credit ratio is the numerical calculation of what you owe compared to available credit. As a rule of thumb, credit bureaus like Equifax give higher credit scores to consumers who maintain low debt-to-credit ratios.
Utilization Speaks Volume on Your Credit Report
In general, lenders follow two methods in order to quantify a consumer’s debt-to-credit or “utilization” ratio. They use these simple calculations (among others) to determine whether they should extend credit.
1. One Revolving Account Ratio
They compare the balance on one revolving account to a consumer’s available credit for that lender. For example, Consumer Cathy has one VISA Credit Card with a $5,000 balance and a $25,000 credit limit. Cathy’s “Debt-to-Credit” ratio is 20% ($5,000./$25,000. = 20%).
2. Total Revolving Account Ratio
A creditor calculates all debts on revolving accounts against the total credit lines on those same accounts. For example, Consumer Colton has five credit cards (Visa, MasterCard, Discover, Platinum Select, and Players Club Card). Each has a $5,000 credit line; Colton has a total of $25,000 in available credit. He has a $1,000 balance on the MasterCard plus zero balances on the other four cards. Colton’s “Debt-to-Credit” ratio is 4% ($1,000/$25,000 = 4%).
No Magic Ratio
When you look at your credit report, you’ll notice there is not a section entitled “Debt-to-Credit” ratio. There’s no magic ratio, however there are some guidelines. A healthy ratio is in the 10% range. Your reward? A potentially higher credit core. On the flip side, ratios in the 40%+ range are considered high. It may be a red flag to potential creditors as it may indicate you’re living beyond your means. I advise my clients to calculate their ratio at least once a quarter. It will keep you in tune with your debt and provide a trigger to think about your overall financial goals.