Credit score determines whether you are eligible to get loan or not. In order to know this score, most of bank or lenders rely on FICO. Several items are the keys to measure score, such as credit history, debt to income ratio, payment period, and credit to debt ratio. Knowing this ratio can help to increase the probability for loan acceptance.
What is Credit to Debt Ratio?
This ratio is straightforward calculation between debt and amount of maximum credit you can have. In credit card, lender will set maximum limit of borrower credit based on credit score. If limit credit is $5,000 on one card, your debt will be at red flag when you spend more than the limit. At store, you can spend $500 and the credit to debt ratio is 10%.
From that calculation, you understand how to measure this ratio. The main issue is not ratio of credit and debt, but how much the ratio turns into red flag. In previous example, 10% seems pretty decent and normal. Few people also spend their credit card for more than 30% from the maximum limit.
In general, there is no definite rule about how much the debt is in single credit card. If you have more than one card, credit to debt ratio is the accumulation from each limit. For example, your cards have limits $2.000, $5.000, and $10.000. Total credit is $17.000 and you should measure all the debts into one, not separately, regardless any limit credit in each of score.
In order to prevent unbalanced credit card debt, you need to spend all cards equally. As you know, card issuer or lender decides to put different limit based on their own assessment. Of course, opening new account will affect existing one, but still the credit score and other factors are the key things including credit to debt ratio.
What are the Functions of Credit to Debt Ratio?
From financial perspective, credit to debt ratio seems to be ordinary number. However, higher ratio indicates that borrower is in critical situation. FICO stated that ratio more than 30% is bad sign, particularly for credit score. You need to maintain credit score above 650 and this ratio should be under 30%. Moreover, the damage point is what they call when the score is below 500 and it takes long time to bring at proper level.
Besides credit score, credit to debt ratio shows your ability to pay and the level of rate. Normally, people spend less than what they earn. It gives advantage to fulfill regular payment monthly without much issue. Unfortunately, there are people who cannot control their desire to shop everything since the credit card is at hand. In this situation, ratio will increase alongside the interest and payment.
How to keep this ratio as low as possible? You can start from consolidating the debts and calculating the budget. Keep spending at balance proportion on each card. Do not push the limit or even reach more than 30% when spending credit card. Most importantly, pay the debt more than minimum payment because it can help credit score to rise. Therefore, keeping the credit to debt ratio lower is the best way to stay out of trouble.