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Debt-To-Credit Ratio the banks won't tell you about
Chris Gunnels
http://findacreditsolution.com
You may not spend much time thinking about your debt-to-credit ratio, but it actually weighs heavily on your credit score and can determine your ability to get a loan. Debt to credit ratio, in lay-mans terms (or simple mans, for those of use who don't like fancy talk) is this:
How much you owe verses how much you could owe. For example, if you owe $2,000 on a credit card and the credit limit on the credit card is $2,000, then you have a much too high debt-to-credit ratio. To the banks, it looks like you spend everything you can get your hands on. Now let's say you have two credit cards, each with $2,000 limits and you owe $1,000 to each credit card. Your debt is the same, you still owe $2,000 total, BUT now you have $2,000 which you haven't used up yet. You are only using 50% of the credit available to you. Banks see that as constraint on your part, and they think it is wise.
So basically it is better to spread your debt out on multiple cards and so that you haven't used your credit limit on any card, since credit card limits show up on credit reports. However, don't have too many credit cards or this can lower your score as well and make you look overstretched. Consumers know all too well that going over their credit limit can mean a high fee, a higher interest rate and even a lower credit score. But few people are aware that merely approaching their limit can have consequences as well.
Your debt-to-limit ratio is calculated by dividing what you've spent by your total credit limit. As a result of a high debt-to-limit ratio, lenders may increase your annual percentage rate (APR) or deny you a loan - even if you pay off your credit card balance every month and have never exceeded your limit. About 14% of Americans use at least 50% of their available credit, according to Experian's 2007 national score index study. But, experts recommend keeping your debt-to-limit ratio under 30%, or even under 10% if possible (ya, right!). That means if your limit is $10,000, then you should aim to charge less than $1,000 a month. The lower your debt-to-limit ratio, the better your credit score will be. And there are two basic ways to improve your debt utilization: raise your credit limit or lower your debt. Your credit card limit is listed on your monthly bill, but it can change from one billing cycle to the next. That's because credit card issuers can raise or lower your limit as they see fit, although they should notify you of all changes. These notifications are usually in small print on your statement, so just call and ask your limit to be raised. There are many cases where people simply asked for a higher limit, and with good on-time pay history, even in today's tight credit market, many credit card lenders will raise your limit.
"If you have a good credit history your credit card issuer will up your limit, but if your history isn't great then they can say 'No,' which isn't necessarily a bad thing," said Bill Hardekopf, CEO of LowCards.com. "Getting turned down for a higher credit limit may be a blessing in disguise," Hardekopf said. Chances are it is a signal that you should reduce your spending or pay down your credit card balances instead.
When paying down debt, it's important to consider that your debt utilization is calculated per card and cumulatively. That means that leaving one card nearly maxed out will negate all the hard work you've done paying down the balances on other cards, so pay them all down equally. If you only have a few credit cards, transfer part of a balance from an old card to a new 0% balance transfer card , and increase your credit score in the process. Click here for the best rated cards for this tactic.
And a higher limit isn't always better. "If you are a spender and the temptation is there to spend more than what you can really afford, [then a higher credit card limit] can send you into the debt spiral," Hardekopf said. It's also possible that potential lenders will view a high credit limit as potential debt, which can count against you if you are trying to get a mortgage or a car loan. Ultimately, "it boils down to how you handle debt. If you handle debt responsibly, then go for a higher limit," said Greg McBride, senior financial analyst at Bankrate.com. Consider whether "that higher credit limit is going to represent temptation to run up additional debt." Ideally, you want to illustrate that you can keep your spending under control, and that means "your focus should be on paying down debt, not racking up more," McBride said.
Avoid:
Signing up for new cards to boost your total available credit and make your debt utilization appear lower can work against you, experts say. In fact, opening new accounts may even lower your credit score if you already have too many accounts.
"Recent credit inquiries constitute 10% of your score," McBride said.
And each new inquiry means points subtracted from your total. Additionally, closing unused cards is also a bad idea, since those are unused debt so that ups your score.
"When you close an account the amount of 'overall' available credit decreases, which could cause an increase in your [debt] utilization and inadvertently lower your score," said Deanna Templeton, director of consumer education for Credit.com.
Published: Wednesday 1st of October 2008 11:18:10 AM
Article submitted Wednesday, October 01, 2008
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