Credit Tips – Third Leg: “Debt-To-Credit-Limit” Ratio
Welcome to the third and final piece of the credit puzzle…
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.
The third and final leg on this three-legged stool is called “utilization,” or your “debt-to-credit-limit ratio.”
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.
Here’s how it works:
- 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.
*Source: PBS Frontline/NY Times Special Report “Secret History of the Credit Card” - GOOD = If you have an account with a current balance less than 50% of it’s 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. Here’s a video of President Obama addressing this very issue of consumer abuse by credit card companies: CNN – Obama Addresses Credit Crunch
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.
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 that negative factor will go away. We’ll also talk about certain debt relief programs that can wipe out your debt balances for you very quickly, which impacts your debt-to-credit-limit ratio in a very positive way.
So that’s the World Famous “Three-Legged Stool” Analogy of “How Credit Works”:
- Payment History
- Debt to Income Ratio (DTI)
- Utilization (Debt to Credit Limit Ratio)
But Wait, There’s More…
To understand consequences to your credit for each option, we must first understand “How Credit Works”.
Do you understand how Debt-To-Credit-Limit Ratio (Utilization) works now?
How is YOUR Debt-To-Credit-Limit Ratio RIGHT NOW?
- Good ? (All debt balances are less than 50% of their credit limits. Remember, the “sweet spot” is 20-25%)
- Bad? (At least one debt balance is over 50% of it’s credit limits. Remember, it only takes one account “over-utilized” to negatively impact your credit)
- Crippled? (At least one debt balance is at 100% of it’s credit limit (MAXED-OUT), OR OVER THE LIMIT. Remember, it only takes one account “over limit” to cripple your credit)
At this point, make a mental note of how your credit is right now…
How is YOUR Credit Right Now OVERALL?
A) All THREE GOOD legs?
B) TWO GOOD legs and ONE BAD leg?
C) ONE GOOD leg and TWO BAD legs?
D) All THREE BAD Legs?
Keep in mind “How Credit Works” and where you credit really is right now as you learn your different options for getting out of debt. I will relate to this three-legged stool analogy throughout this financial educational program so you’ll understand how each option will specifically affect you in your unique situation.
>>> NEXT: Credit “Rating” vs. Credit “Worthiness”
Was this valuable to you? Feedback? Question(s)?
Please share your thoughts and ideas below. I respond to any questions posted as a comment in detail by email.
Thank you for the opportunity to serve you!
Here To Be An Asset To You,
Jesse Niesen
DebtGoToGuy.com
888-928-DEBT
Thank you for spreading the word!
