A debt limit ratio, more often called a debt-to-limit ratio or debt utilization, compares your current debt versus your maximum available credit. Expressed as a percentage, your debt utilization demonstrates your reliance on debt to potential creditors when considering whether to offer you additional debt.
Debt Limit Basics
Your debt limit is the maximum amount of debt you can take on as an individual or business. Individual debt limits typically refer to the credit available to you through personal credit lines and credit cards. For instance, if you have a personal line of credit with a limit of $15,000 and 3 credit cards with a total limit of $30,000, your debt limit is $45,000.
Calculating Debt Utilization
Debt utilization, or your debt limit ratio, is calculated by taking the total amount of available debt in use and dividing it by your debt limit. If you currently use $4,000 of your personal credit line and $5,000 of the available credit limits noted above, your debt limit ratio is $9,000 divided by $45,000. This is one-fifth of your available debt in use or a 20 percent debt limit ratio.
Technically, you could reach a debt limit ratio of 100 percent. If you use all $45,000 of your available debt, you have expired your debt limit and must either pay down your balance or get more credit to reduce your ratio. Practically, a debt limit below 30 percent is considered "very good" and helps you attain a stronger credit score, according to SavingAdvice.com.
Credit Score Effects
Your debt utilization is viewed by credit reporting agencies and creditors as an indication of your risk as a potential borrower. Someone with a higher debt limit ratio is perceived as more debt reliant and a greater risk with new debt. Your debt limit ratio makes up 30 percent of credit score, with credit history the only factor that contributes more to your score. Thus, maintaining a debt limit ratio below 30 percent is a wise financial goal. Keeping debt limit ratios on individual credit accounts below 30 percent, or 50 percent at most, is also a good idea.
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