Having credit is a vital part of any adult life but knowing when and how to use it is actually more important bit of financial knowledge that all people need to have. The simple fact is that, no matter how much credit you have, you never want to use it all at the same time because if you do your credit score can actually take a huge hit and drop significantly.
It can be quite deceptive, to be sure. For example, if you’ve been given a $2000 credit line and the first thing that most people would assume will is that, if they stay within that limit and pay their balances in full every month all would be well.
The reality is that, due to a very important financial idea called the debt to credit limit ratio, this is sometimes not true at all. In fact, a person’s debt to credit limit ratio is probably one of the most vitally important measurements that is used to determine their credit score.
If you’re keen on determining what yours is, all you need to do is find the aggregate outstanding balance of all the debt on your credit cards and the actual total amount of credit you have on those cards. With some simple math you’ll then have your exact debt to credit limit ratio.
The next question is simply this; what’s the ideal debt to credit limit ratio?
Well, according to VantageScore Solutions, you definitely should strive to keep your debt to credit limit ratio below 30%. If you go by the numbers given at FICO, the credit scoring system, you’ll want to keep that at around 7%. Indeed, the consumers who generally have the highest FICO scores generally have the lowest debt credit limit ratios.
It’s also important to understand how this ratio is actually calculated. When you’re creditors report to the Big 3 credit bureaus about how much credit you’re using and what your balances are, the credit bureaus will then calculate your ratio based on your most recent statements. If, for example, you have a credit card with a limit of $2000 and your May 2013 balance was $1600, your debt to credit limit ratio will be reported at that time as 80%. It doesn’t matter if you just paid off your balance in full the day after your statement date, once the numbers are presented to the credit bureaus your ratio is determined and won’t change for another 30 days.
The people who have the toughest time with their debt to credit limit ratio are those who have the lowest amount of credit. For example, if you only have a credit line $500 and you’re keen on keeping your ratio under 30% limit that VantageScore Solutions recommends, it would mean that you can only use $150 of your credit at any one time.
One of the ways to work around this is to make sure that you always pay off any balances before your statement has been generated. Limiting your credit card use is also a great way to control your ratio as well as knowing exactly when the closing date of your statement is. Knowing the date you can pay your bill online before the statement closes basically ensures that the credit bureaus see a zero dollar balance on your statement or at least a lower balance (depending on how much you actually paid).
Another way that you can ensure that your debt to credit ratio doesn’t go too high is to have 1 or 2 credit cards in your name that are open but that you rarely or never use. Having this extra credit that’s unused will actually lower your debt to credit ratio and possibly allow you to use more of your credit on the other cards that you normally use.
One common misconception that people have about their credit limit is that, if they keep maxing out their limits, there credit card company will be more likely to increase the limit. While that’s possible, it’s not exactly a set rule. In some cases, you actually manage your credit line canceled because you maxing out all the time. What it boils down to is how much risk you pose and, if you’re low risk, you may get array with it for a little bit longer.
In the end, knowing what your exact debt to credit ratio is, keeping a low and paying off your credit cards on time, every time, will actually allow you to increase your credit overtime and give you more purchasing power. If you have any questions about your debt to credit ratio or other financial issues please let us know and we’ll be sure to get back to you ASAP. Thanks.