What is the Debt-to-Limit Ratio?

Your credit health is a vital component of your financial future. Strong credit can help you qualify for loans with low-interest rates, while conversely, poor credit could become a barrier that stops you from getting the loan you need to buy a home, finding financing to purchase a car, or qualifying for the credit cards with the best rewards and rates. Properly navigating this credit landscape is a complex process. But you will be able to succeed and accomplish your financial goals once you have a better understanding of how your credit score is calculated. In this article, we run through what the debt-to-limit ratio is and how it plays a large role in determining your credit score.

How is Your Credit Score Determined

Your credit score is a three-digit number that sums up the information in your credit report, including your payment history and your credit card balances. Lenders use this metric as a way to determine your credit health, with the score designed to predict the likelihood that you can meet your payment obligations. 

Importantly, you are not assigned just one credit score. We all have multiple credit scores that are slightly different because there are multiple credit bureaus, who each have slightly different scoring methodologies, with the two known scores being a FICO Score and a VantageScore. While each scoring model is slightly different, the key components remain the same. Your payment history, debt-to-limit ratio, age of credit, type of accounts and application history all factor in determining a credit score. 

Why Your Debt-to-Limit Ratio is So Important

Also known as your credit utilization ratio, your debt-to-limit ratio measures the amount of your overall credit card limit that you are using. It is calculated by dividing your total outstanding balances on all of your cards by your total credit limit. The lower your debt-to-limit ratio the better, but in general, a good rule of thumb is to keep this figure below 30%. A debt-to-limit ratio can lower your credit score as it may make potential lenders worry that you are overextended and may not be able to handle more debt. Accordingly, the bureaus lower your score which effectively reduces the amount of additional credit you’re able to take.  To lower your debt-to-limit ratio, you can either pay off your debt or increase your credit limit.

Conclusion

Strong credit health will be necessary for you to achieve your financial goals, whether that’s getting a low-interest personal loan to consolidate your credit card debt or buying your first home. While your payment history is the most important factor in achieving good credit, your debt-to-limit ratio or credit utilization ratio is vital. Keeping this figure below the 30% threshold is one of the best ways to build up and maintain your credit score.