Understanding Your Debt to Credit Ratio

Your debt-to-credit ratio is the percentage of available credit you currently use. It’s an important financial metric to understand because lenders use it to determine how much you can borrow and your interest rate.

Before applying for a personal loan, you can use a debt-to-credit ratio calculator to assess your creditworthiness and understand the type and size of a loan you may be eligible for.

At Tower Loan, we’ve found that new clients occasionally misunderstand the difference between debt-to-credit ratio and debt-to-income (DTI) ratio. Therefore, we’d like to clear up any confusion between these two ratios while helping you understand what is a good debt ratio and why it matters. 

What Is Debt-to-Credit Ratio?

A debt-to-credit ratio is sometimes referred to as a debt-to-credit rate or credit utilization rate.

It is a calculation of the revolving credit you use divided by the credit you have available. Put another way, it’s the percentage of revolving credit you’re utilizing compared to your total credit limit.

Examples of revolving credit are lines of credit and credit cards, which don’t require fixed monthly payments. Installment loans, like the ones we offer at Tower Loan, are not revolving credit because they require you to stick to an established payment structure with a predictable, consistent payment plan.

How to Calculate Debt Ratio

Calculating your debt-to-credit ratio involves dividing your total balance owed across all cards by the total of your credit limits.

Here’s an example:

• You have three credit cards with credit limits of $1,000, $2,000, and $5,000.
• Therefore, the total credit available to you is the sum of those numbers, $8,000.
• You have a balance of $300 on each of your three cards. 
• Therefore, your total revolving credit debt owed is $900.
• $900 in debt divided by $8,000 in total credit = 11.25%
• Your debt-to-credit ratio is 11.25%.

What Is a Good Debt Ratio?

Many people wonder, “What is a good debt ratio?” so they know what percentage to strive for.

Lenders typically look for debt-to-credit ratios of 30% or less, which indicates that a borrower is less likely to be a financial risk. So, in the above example of a debt-to-credit ratio calculator, an 11.25% debt-to-credit ratio would be considered a good indicator that you could confidently pay back a loan based on your financial patterns.

Why Does Debt-to-Credit Ratio Matter?

Now that you know how to find debt ratio, why does it matter?

First, debt-to-credit ratios have an impact on credit scores. A low ratio reflects responsible credit use, while a high ratio may signal a risk to potential lenders.

If you can keep your debt-to-credit ratio under 30%, you have a better chance of securing a loan when you need it. The debt-to-credit ratio also plays a role in credit utilization, which is a major factor in credit score calculations.

Debt-to-Credit Ratio vs. Debt-to-Income Ratio

In contrast to the debt-to-credit ratio, your debt-to-income ratio (DTI) represents the total amount of debt that you carry versus your total monthly income. This is a separate calculation with a clear distinction between the two metrics.

Debt-to-credit focuses on your revolving credit. Meanwhile, DTI compares your debt obligations to how much money you bring in from your job or other sources of income.

DTI does not have a direct impact on your credit score. However, lenders use both metrics in evaluating borrowers. Lenders may look at both ratios to decide whether to approve your funding request because one demonstrates how you use credit and the other shows how you can keep up with payments based on money earned.

Is a Low Debt-to-Credit Ratio Always Good?

It is a common misconception that having a low debt-to-credit ratio is always a good thing.

There are certainly benefits to maintaining a low ratio, such as getting a better credit score and having higher chances of being approved for a loan. However, there are a few potential drawbacks, too.

For example, if you close old credit accounts to achieve a low debt-to-credit ratio, you will reduce your total credit limits. This affects the ratio and perhaps not in your favor. It may be a better option to pay off credit card debt but leave existing accounts open.

How to Improve Your Debt-to-Credit Ratio

Once you understand how to figure credit to debt ratio, you’ll likely want to take practical steps to improve it for greater financial flexibility and purchasing power in the future.

One way to improve your debt-to-credit ratio is to pay down current credit card balances. You might do this by prioritizing high-interest debt first to minimize the amount you have to spend each month on interest.

Another option is to increase the credit limits on your existing credit cards. You could request a limit increase from your current credit card issuer or open a new credit account to impact your debt-to-credit ratio calculator. However, use this strategy with caution so you don’t drive yourself deeper into debt.

To improve your debt-to-credit ratio, you should keep balances well below the allowable limits and avoid maxing out credit cards. It is also helpful to regularly monitor your credit so that you can effectively track your improvement progress and notice errors as soon as possible.

If you’re concerned about improving your DTI ratio instead, you might consider paying more each month toward existing debt and delaying any new large purchases to avoid increasing your overall debt load.

When Is It a Good Idea to Focus on Your Debt-to-Credit Ratio?

There are certain times in your life when a debt-to-credit ratio may matter more than other times based on what you are going through and your goals.

Improving your ratio is crucial in some situations, such as when you are applying for a mortgage or other large loan. It is also important to improve your ratio if you are planning to refinance and need a boost in your credit score.

However, there are other times when the debt-to-credit ratio isn’t as relevant or matters as much. If you’re not planning to take out any new credit soon, you can likely focus on other financial goals, such as establishing an emergency fund or saving for retirement. 

Discuss your Debt-to-Credit Ratio with Tower Loan

If you have further questions about how to calculate debt-to-credit ratio and how it could impact your chances of obtaining a personal loan, please contact us.

We offer a fast and convenient way to borrow funds with a straightforward online application process that takes as little as 10 minutes. Our personal loans come with flexible terms to accommodate different financial situations and dedicated customer service with many branches across six states.

Start the application process today from the comfort of your home, or visit your local branch to learn more about debt-to-credit ratios and other factors we consider when making each loan.