Available Credit to Debt Ratio: What it Means to Your Credit Score

Tristan Powys (Credit Counsellor) @ Lucid Living

Most people understand the basic premise behind building or maintaining a good credit score: pay the bills on time, every month, consistently. Miss a payment, or default on a loan or credit card, and your credit history will reflect that negative information and lower your credit score. However, there are many other factors involved when it comes to determining your actual credit score, and not all of them have to do with whether or not you pay your bills on time each month.

Your available credit to debt ratio is a big factor when it comes to figuring up your credit score. Your available credit to debt ratio can impact your credit score based upon not only your spending habits, but your debt-management plan as well.

Your available credit to debt ratio is, simply put, the amount of debt you currently carry, divided by the amount of your available credit. For example, if you have a credit card with a R1000 limit and you carry a R500 balance, your available credit to debt ratio is 50%. The lower this ratio, the better your credit score will be. Ideally, you should aim for a total credit to debt ratio of 30% or less. A high ratio will negatively impact your credit score even if you make all of your payments on time. This is because people who use most or all of their available credit are seen as having a higher risk of default.

It may seem as though the answer to improving your credit to debt ratio is to open more credit card accounts. In reality, opening multiple accounts in a short period of time will negatively impact your credit score. Your best option, if you have been making payments on time regularly, is to call and ask for a modest increase to your credit limit. This helps in two ways – first of all, it is an increased limit on a credit facility that has a successful payment history. Secondly, it increases your overall available credit, which will lower your available credit to debt ratio, improving your credit score.

By the same token, if you have credit cards that you have paid off recently, don’t cancel them. The available credit on those cards still counts as part of your available credit to debt ratio. If you’re worried that you might be tempted to spend, take the cards out of your wallet and put them in a safe place that isn’t easily accessible for impulse purchases. Every six months or so, you may want to use the cards for a small purchase such as dinner or a movie, in order to keep the accounts from being canceled due to inactivity. Be sure to pay the full balance on the card when it comes due, in order to keep your debt ratio down.

Another way to improve the available credit to debt ratio is to pay more than your minimum balance each month. Besides being an excellent financial advice, paying more will free up more of your credit, and lower your available credit to debt ratio. One word of caution, however: if you have several credit cards with very high limits that you are not using, and that carry no balance, you may want to ask to have the limits lowered temporarily if you are in the market for a car or other large purchase. Some companies see an excessive amount of unused credit as potential debt, and may be reluctant to loan funds in that instance. In most cases, however, this credit will not work against you, but for you as you continue to build a solid credit history that will keep your credit score climbing.