Welcome to the third and final piece of the credit puzzle... "Debt to Credit Limit" Ratio You're just about to completely understand "How Credit Works...
Welcome to the third and final piece of the credit puzzle...
"Debt to Credit Limit" Ratio
You're just about to completely understand "How Credit Works" and gain an exact understanding of where your credit is right now. This will help you make your best choice to be debt free ASAP by understanding how each option to get out of debt will affect your credit, now and in the future.
This third and final leg on the three-legged stool called "utilization," or your "debt-to-credit-limit ratio", makes up about 30% of your entire credit score.
This is probably the least known and most misunderstood factor affecting your credit. The way this works is very interesting. Basically, each account you have has a credit limit and a current balance. The use or "utilization" of your available credit affects your credit rating and credit worthiness for EACH account you have, as well as all of your credit accounts combined.
Rules of thumb about debt-to-credit-limit ratios:
BEST = The "sweet spot" is keeping your balances at 20-25% of their limit. Paying off your balances every month will actually hurt you. Credit card companies refer to you as a "deadbeat" because you are basically using their money for free without paying them interest. This is great for you, (highly recommended over paying interest, if you can manage it) but not good for the creditor. Their ideal customer is the one paying the most interest, and since they make their money charging you interest, they penalize you for keeping your balances at 0%. To get the best credit rating without triggering any negative effects (especially to build or rebuild your credit), charge your cards up under 50% of the balance and pay them down to 20-25% each month.
GOOD = If you have an account with a current balance less than 50% of its credit limit, then that's a positive factor for your credit.
BAD = If you have an account that's over 50% utilized (meaning the current balance is over 50% of the credit limit), then it becomes a negative factor for your credit. It becomes more severely negative if the current balance goes over 75% of the credit limit.
CRIPPLED = If you have an account that's "maxed out" (100% utilized; the current balance is at the credit limit), especially if it's "over the limit" (the current balance EXCEEDS the credit limit) your "debt-to-credit-limit ratio" is effectively crippling your credit and credit worthiness.
Again, you can have a perfect payment history, you may have always made your payments on time or early, but if you've got an over the limit account then you're going to be stuck. Having a BAD or CRIPPLED "third leg" can trigger "universal default" causing your interest rates to jump to 20-30% or more, even on other accounts with low balances. It's just another sneaky trick the credit card companies are playing on you.
You should always look at your utilization before applying for any major financing like a new home loan, a mortgage refinance or buying an automobile. A bad or crippled debt-to-credit-limit ratio can hurt you, resulting in much higher fees, payments, finance charges and interest costs if it doesn't disqualify you completely.
Tip to Quickly Improve Your Debt-to-Credit-Limit Ratio
Perhaps you're one of the people that are concerned about a mortgage going to an adjustable rate, or this conversion already happened and you're paying too much for your mortgage. You need to refinance. Your debt-to-credit-limit ratio is going to be a big issue for you very quickly. One quick trick that might work you is this: Simply call and ask the creditor to increase the limit, if they can increase that limit to twice or more of your current balance you've effectively improved that area of your credit! It will go from a negative to a positive right away.
Keep your debt-to-credit-limit ratio in mind because the credit bureaus weigh heavily on it. Obviously, if you've got a card that's maxed out, like most Americans, it has a negative effect on your credit. How can you fix that? The most basic way is to pay it down below 50%, and the negative effect will go away. Certain debt relief programs can wipe out your debt balances for you very quickly, which impacts your debt-to-credit-limit ratio in a very positive way.
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