Your debt-to-credit ratio—also called your credit utilization ratio—is an important factor used in calculating your credit score, which lenders use to gauge your risk as a borrower. For this reason, it’s critical to understand if you’ve overextended yourself and if your debt-to-credit ratio could hurt you in the future.
What is a debt-to-credit ratio?
Your debt-to-credit ratio is the amount of debt you have outstanding compared to the amount of credit that has been extended to you. For example, if you have two credit cards, one with a credit line of $1,000 and one with a credit line of $500, your total available credit is $1,500. If you were to charge $500 on the first credit card, your total available credit would be $1,000, and your debt-to-credit ratio would be 33 percent.
(Read more: What Information Is on My Credit Report?)
How to calculate your ratio
It’s very simple to calculate your debt-to-credit ratio. First, add together all the available credit lines you’ve been extended (using the example above, $1,500). Then, add up all the debt accumulated on those credit lines ($500), and divide the total debt by the total available credit ($500/$1,500) to get your debt-to-credit ratio (33 percent).
Once you’ve calculated your debt-to-credit ratio, understand what it means for you. In general, lenders like to see borrowers with debt-to-credit ratios at or below 30 percent for optimum borrowing potential. Anything lower is very good. Anything higher could mean that you may not be approved for credit or that credit could cost you more in the form of a higher interest rate.
How to improve your ratio
The quickest way to improve your debt-to-credit ratio is to pay down your debts and focus on responsibly using the credit you have. A great way to motivate yourself is to think about the opportunities life affords you when you are not carrying a lot of debt.
Make a plan and track expenses
You can make a debt reduction plan and improve your debt-to-credit ratio by using online tools and calculators to help you. If you don’t already have a plan in place, start by building a budget to help you identify and prioritize expenses. Then, organize your debts and determine how quickly you can pay them down by adjusting the interest rates or the amount you pay each month. In some cases, adjusting the interest rate may be as simple as making a call to your creditors to ask if a lower rate is available.
You may find that tracking your expenses helps identify areas where you can cut costs so you can use the savings to pay more toward your debts each month.
If you feel as though you can’t do it alone, seek help. Consider speaking with a nonprofit credit counseling service, such as ClearPoint Credit Counseling Solutions (CCCS).
Check your ratio periodically
Stay on track by checking your debt-to-credit ratio periodically as you pay down your debts. Review the balances of all your outstanding debt obligations and compare them to the available credit you have.
If you don’t have the optimum ratio, don’t give up. Continue to pay down your debts and avoid obtaining any new debt during this time period. Over time, as you pay down your debts, you may see your credit score getting healthier, and your ability to obtain more favorable rates on future credit can increase as well.
Mechel Glass is the vice president of education for ClearPoint Credit Counseling Solutions. She is responsible for developing the curriculum and financial education materials for online classes including webinars, podcasts, videos, and listen-on-demand classes. She provides support and training for the agency’s community outreach programs and staff, including financial education specialists in 15 states. Glass also manages the development and reporting of the agency’s online education, and she is the co-author of The Veteran’s Money Book (Career Press, April 2014).