Credit Card Guide
What Is Debt To Available Credit Ratio?
The debt to available credit ratio, also known as credit utilization, is the amount of money an individual has in outstanding debts compared against the amount of credit still available on all of that same individuals credit cards. The higher an individual's debt to available credit ratio, the bigger a risk they appear to potential lenders.
If you have a good understanding of how the debt to available credit ratio works, then you can use it to your advantage as a means to improve your FICO score. One of the largest myths regarding improving your credit score is that you should close any credit accounts no longer in use. In reality, by closing a credit card account you are effectively eliminating your payment history for that particular credit card account. While the card will show up on a credit report, it will no longer be counted toward the payment history portion of your credit score.
How Is Debt To Credit Ratio Calculated?
A consumer's debt to available credit ratio is calculated by comparing the amount of money that is owed to how much can still be borrowed from the same lender. As an example, if you have a credit card with a $2,000 credit limit and you have charged $1,000, that would give you a debt to available credit ratio of 50%. The lower your ratio, the better your chance of borrowing additional money. Therefore, if a credit card account is paid off completely it would show that no outstanding debt is held and you can still borrow the full amount of whatever credit limit was offered. If you were to close that account, you would lose this positive debt to available credit ratio. This could have a detrimental bearing on your credit score as a whole.
Should You Always Leave Unused Accounts Open?
If you already have a fairly good debt to available credit ratio from other sources then you do not really need to keep unused credit cards open. In general, you should try to have a debt to credit ratio of around 50% or less. So if you feel that your remaining accounts will provide a strong enough credit history and a decent debt to credit ratio then you can close the account with no FICO score worries. If you do intend to keep the account open there are other factors to consider such as does the card have an annual fee? If it does then there is no point in paying a fee for an account you are not actively using other than to boost your credit score. It is also advisable not to have too many unused credit accounts as this can have a negative impact on your credit score. If you have paid off several accounts in a bid to reduce debts, then it is worth reviewing your finances and closing all but one of those accounts.
How Important Is Debt To Credit Ratio?
Next to payment history, your debt to available credit ratio has the largest impact on your FICO score. Financial experts generally agree that a debt to credit ratio of between 40% and 60% offers an acceptable score. However, the lower your ratio, the more additional points you gain on your credit score, while the higher it is, the more FICO points you lose. Even if you are always able to make payments on time, having a high debt to available credit ratio can lower your credit score substantially, making it difficult to obtain additional borrowings. It is important to try and keep low balances on your cards as much as possible. Paying a card off in full each month is no guarantee of a favorable debt to credit ratio as card issuers can report to credit bureaus at any time.
In conclusion, having a low debt to available credit ratio can have a positive impact on your credit score and ability to obtain additional credit as it forms a large portion of your FICO score.
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