Keeping debt within reasonable limits is the key to both financial freedom and a stellar credit score. However, it is sometimes difficult to know what the boundaries for spending are. Financial experts have created guidelines to assist consumers in determining when to stop spending so that they may be eligible for the best interest rates and financial opportunities down the road.
Debt Utilization Ratio
Debt utilization ratio refers to the amount of debt you have versus the amount of credit available to you. The more debt you accumulate, the less credit you have to spend. This figure plays largely into the calculation of your credit score, constituting about one-third of your overall score.
Credit Card Limits
Since your debt utilization ratio weighs heavily on your credit score, it's important to keep your balances low. Finance experts at the Better Business Bureau recommend keeping balances to 25 percent of your credit limit. Keeping low balances demonstrates to creditors that you are a responsible consumer, capable of paying off your debts and restraining yourself from overspending. Those traits are then reflected in your credit score.
Debt to Income Ratio
In addition to credit cards, the average American household has debts including a mortgage, home equity loan, auto loan, student loan and retail financing plan. The total percentage of debt should ideally be within the range of 36 to 40 percent of your income at most, according to the financial planning website Say Planning. Anything higher than that, and you should consider getting extra employment and seeking credit counseling.
Considerations
Although it's important to keep your debt low, not using your credit at all may also damage your score. In an interview with Bankrate, FICO product specialist Barry Paperno explains that you should use each credit card at least once every six months. Pay off the balance, and you won't have to worry about affecting your debt utilization ratio -- or making monthly payments.
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