Your credit situation may be mystifying if you don't understand the terminology used in the literature and by finance professionals; however, the term "debt to credit ratio" actually means what it says. Lenders and creditors look at how much debt you have, and compare it to how much room you've left yourself before you reach your account limits, and use this ratio to assess how much of a credit risk you are.
Definition
Your debt to credit ratio is how much you owe in proportion to how much credit you have available for use. For example, if you have a $600 balance on a $1,000 credit card, your debt to credit ratio is $600 to $400, or 60 percent to 40 percent. Your debt to credit ratio is used to determine how financially responsible you are.
Credit Score
Your debt to credit ratio is one of the key factors in determining your credit score. According to Fair Isaacs Corporation, known as FICO, your debt to credit ratio, called the utilization ratio, accounts for one-third of your overall credit score. FICO recommends keeping balances below 30 percent to get your credit score as high as possible.
Warnings
If your debt to credit ratio is high, you may have difficulty obtaining new credit. Consumers with lots of revolving debt have problems getting approved for new credit because it demonstrates to lenders that you may have problems managing your money. When your balances are low, lenders see that you are responsible and have the means to pay back any loans or new credit.
Expert Insight
To get your debt down and your available credit up, you must start paying off your balances. You may either choose to pay off the lowest balance first, in what is called the snowball plan, or to pay off the card with the highest interest rate first. The benefit of the snowball plan is that you'll see the effects of your increased payments sooner, since the card will be paid off quickly. By paying the card with the highest interest first, you save money by decreasing the time frame in which you are paying the interest.
Considerations
Your credit report details your debt to credit ratio. Each year, you may obtain a free copy of your credit report from each of the three credit bureaus (Experian, Equifax and TransUnion) through the Annual Credit Report website. Also, to reduce your debt to credit ratio faster, call your credit card companies to request lower interest rates. If you are having difficulty making payments and want to get out of debt, consider working with a credit counselor to create a budget and a payoff plan.
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