What is the best debt to credit ratio?
We get asked this question a lot by our current clients and potential clients: “What is the best debt to credit ratio?” First, we must explain what a debt to credit ratio is. To put it in layman’s terms, it is how much you owe versus your total available credit limit. A debt to credit ratio is also known as credit utilization.
Figuring out your debt to credit ratio is not hard at all. Let’s say you have a credit card with an $8,000 credit limit on it, and you have a balance of $5,000 due. Your debt to credit ratio would be: 5,000 ÷ 8,000 = 0.625 ratio or 63 percent utilization of your available credit. So, what does that mean? Is it bad to have a debt to credit ratio of 63%? What is the best debt to credit ratio?
Those are tough questions, and they can have several answers. The reason is that no one’s credit report is exactly the same, and while we know a few things about what makes up FICO’s credit scoring system, we don’t know the exact algorithm or formula. It’s all just speculation. The best anyone can do is to make an educated guess based upon all of the various clues or hints that FICO has given out over the years.
The credit gurus say that you should not use more than 20-30 percent of your credit limit on any given credit card. FICO released a list of “damage points” back in 2009 which are common mistakes and what their effect on your credit score could be. While most of FICO’s damage points apply to severe offenses like foreclosure, bankruptcy, and debt settlement (not to be confused with debt management), there are a few clues relating to the debt to credit ratio credit score impact when it comes to maxing out a credit card: 680 credit score with 1 maxed out credit card = 10 to 30 point drop, and a 780 credit score with 1 maxed out credit card = 25 to 45 point drop. This doesn’t tell us much, but it does confirm the fact that having too high of a balance – even if it’s only 1 credit card – could negatively impact your credit score.
With all that said, we’re still left with the question: “What is the best debt to credit ratio?” More than likely you’ll get a different answer from each person that you ask. The general opinion is that the answer isn’t black and white. The degree of impact largely depends upon how old and how healthy your credit is. While there’s no denying a good ratio is a low one, how your ratio affects your credit score will be influenced by many other factors. So it’s pretty much impossible to answer that question truthfully, because we just don’t know. It’s usually considered a good idea to keep your debt to credit ratio under 20%.
So how do you keep your debt to credit ratio low? Well, the easiest way is to pay off your debt as quickly as possible. Find all of your maxed out credit cards (if you have any) and work on those first. You have to decrease your debt, because it will be hard to increase your credit if you get denied for a loan or credit card based of your poor debt to credit ratio.
If you need help decreasing your credit card debt, talk to one of our certified credit counselors and find out what your best debt relief options are. Our credit counseling sessions are completely free and confidential. We’ve helped thousands of people get out of debt, and we can help you too!