Credit Debt Ratio: Why It Is Important to Keep Revolving Credit Balances Down
Once a person establishes credit by obtaining a credit card, car loan, home loan, bank loan or any other type of credit, they run the risk of taking their new found financial freedom too far. It can be very tempting to make purchases on a new credit card or to obtain even more credit once they see how easy it is to get what they want with their signature.
Retailers don’t help either. They lure customers in with promises of savings and assure them that they have excellent credit by making them a premiere customer. Unfortunately, no one seems to tell them that they are ruining their credit by taking out too much credit until it’s too late.
If you have decent credit, you need to be aware of this trap. You need to know how much is too much, and you need to know how to avoid being buried by too much debt. There are two main things that you should be looking at: your debt to income ratio and your credit debt ratio.
Both of these calculations give lenders a clear picture of your overall financial picture. If you’re numbers are high, it will appear that are overextended and your credit score will take a huge hit.
Let’s take a closer look at these two key components:
* Debt Income Ratio You can calculate your debt to income ratio by comparing your gross monthly pay with your monthly bills. Remember, only debt applies here. You do not need to figure in utility bills, insurance payments, etc. You only need to include the bills that you owe to creditors. Your ratio should be less than 36%. If your numbers are higher than this, you need to work aggressively to pay off some bills.
* Credit Debt Ratio Your credit debt ratio is a bit different. You calculate this number by adding up the total amount of credit extended to you and comparing it with the amount of credit that you have used. For example: If you have a credit card with a $2,000 limit but have only spent $250, you would compare these numbers. Your debt should not exceed 25% of the amount extended to you on revolving accounts.
As mentioned before, these numbers show lenders how well you are doing financially. As these numbers rise, your credit score goes down. You will still be able to qualify for credit however, your interest rates will be higher.
You see, lenders calculate your interest rate based on how much of a risk they think you are. If your debt to income ratio is 50% or more, it raises the likelihood that you will default or declare bankruptcy.
Keeping these numbers down is vital. You will enjoy lower interest rates when you do borrow money, and you will always know that you will be able to pay your bills every month.
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