Written by: Brittney Mayer
Edited by: Lillian Guevara-Castro
Reviewed by: Ashley Fricker
As with many complex fields, a lot of jargon exists in the world of finance (because, you know, that’s what complicated subjects need — a lot of mumbo jumbo that makes them even harder to understand).
Making matters worse, some of those difficult terms are actually redundant, i.e., they mean the same thing as other terms. This not only makes it harder to figure out what you should know, it can even make it challenging to determine what you already know.
For instance, think of your debt-to-credit ratio — this sometimes less-than-common term is actually referring to the same thing as your credit utilization ratio (or rate), which is an important part of your credit score.
It’s also a term you may already be familiar with if you’ve spent time learning about your credit. Though its multiple names may be confusing, your debt-to-credit ratio is both important to know — and fairly easy to understand.
In this article, we’ll examine the definition of debt-to-credit ratio, how to calculate it, how to improve the ratio, and look at a few credit accounts that may help you improve your credit utilization rate.
1. Your Debt-to-Credit Ratio is Part of Your Credit Score
In the most basic terms, your debt-to-credit ratio — or credit utilization ratio, or balance-to-limit ratio — is the amount of debt you currently have, versus the amount of credit you have available. For example, if you have three credit cards, each with a balance of $100 and a credit limit of $1,000, you have $300 in debt and $3,000 in potential credit. Your credit utilization, or debt-to-credit ratio, is 10%.
When companies request your FICO credit score, your credit utilization is one of the factors that contributes to your score. In fact, the amount of available credit you are using, and, to a lesser extent, the type of that credit, will determine 30% of your credit score.
Your credit utilization is also an important factor in your VantageScore — the other commonly used consumer credit score. Although VantageScore doesn’t break down its categories into percentages like a FICO score, it refers to debt-to-credit ratio as a highly influential consideration.
2. You Can Easily Find Your Ratio with an Online Calculator
One of the best ways to figure out your debt-to-credit ratio is also a good way to keep an eye on your finances in general: through a spreadsheet. On your spreadsheet, you can use a line for each account, including the total balance and total credit limit. Sum the balance for each account, as well as the total credit limit for each account. Divide your total debt by your total credit to calculate your ratio.
| Account | Balance | Limit |
|---|---|---|
| Credit Card 1 | $253 | $1,000 |
| Credit Card 2 | $717 | $2,500 |
| Credit Card 3 | $0 | $1,500 |
| Total | $970 | $5,000 |
In the example above, the total amount of debt carried across the accounts is $970, and the total available credit is $5,000. Calculating the ratio requires dividing the debt by the credit, giving $970/$5,000, which equals 0.194 — a credit utilization rate of 19.4%.
If you don’t want the bother of creating a spreadsheet or table of your accounts to determine your debt-to-credit ratio, you can let someone else do the heavy lifting. Online calculators, such as the one provided here, can be an easy way to determine your utilization rate. Simply input your balances and limits, and allow the calculator to do the rest.
3. Your Credit Score Increases When Your Ratio Improves
Of course, since your credit utilization rate plays such a large role in your credit score calculations, it should come as no surprise that improving your debt-to-credit ratio can improve your credit score. In fact, your debt-to-credit ratio is one of the only factors impacting your credit score that you can use to influence your score in a matter of weeks.
Most credit providers send your updated balances to the credit bureaus each statement period. That means you may be able to improve your FICO score simply by paying down your current balances, which will improve your utilization rate (unless you increase your debt via other accounts).
Though a general guideline is to keep your utilization rate below 30%, this is a situation in which less is definitely better — especially if you will be applying for any large loans, like a mortgage. One way to improve your utilization rate without needing to pay down current balances is to simply increase your available credit by opening a new account.
By increasing your total available credit, the ratio of debt to credit decreases, improving your utilization rate and, in many cases, your credit score. Keep in mind that you may see a small dip in your score from the hard credit check during the application process, as well as a potential ding in your average account age from opening a new account.
4. You Can Have a Good Ratio and Still Carry Debt
As in all things, there are few absolutes in personal finance. Sure, it is a good idea to aim for as low of a debt-to-credit ratio as you can possibly maintain, but, in the end — life happens. You don’t need to be debt-free to have a satisfactory utilization rate, or a good credit score.
While you should aim for a low utilization rate, a good rule of thumb is to keep your total debt below 30% of your available credit. And, remember that your credit score is updated regularly, so the impact of carrying a high total balance can be quickly remedied by paying down that balance.
5. You Need a Good Ratio to Get the Best Rates
Your credit utilization rate factors into around 30% of your credit score, which means almost one-third of your score is determined by how much debt you have versus how much credit lenders have been willing to give you. If you have a high credit utilization rate, your credit score will reflect that — by lowering.
In general, the lower your credit score, the higher your interest rates. Potential borrowers who have expended a large portion of their available credit often have a higher potential for default and appear to be riskier borrowers to lenders. Risky borrowers get high rates.
6. Your Debt-to-Credit & Debt-to-Income Ratios are Different
For all its many names, including credit utilization rate and balance-to-limit ratio, your debt-to-credit ratio is a fairly simple number that has a big impact on your credit score. As with a lot of jargon, however, it can be easy to mistake one of the many terms that describe this important number with other terms that sound similar, such as your debt-to-income ratio.
Calculated by dividing the amount of your total debt by your total income — sometimes over a set period of time, such as monthly debt payments to monthly income — your debt-to-income ratio may be a factor in some lending decisions. That said, unlike your debt-to-credit ratio, your debt-to-income ratio does not directly impact your credit score.
