Last year, one of my girlfriends and I decided that we were going to pay off our credit cards at the same time. I was paying down debt to start my snowball and get me one step closer to Dave Ramsey’s Baby Step Three. She was knocking down her revolving debt before she purchased her first home. In the process of us paying down our credit cards, we were both offered limit increases from our perspective credit card companies. I accepted the increase and she declined. Her rationale to decline was that she was trying to get rid of her monthly credit card payments because a limit increase would only entice her to spend. For me, accepting the almost $5,000.00 increase meant that I was lowering my debt to credit ratio.
What is A Debt to Credit Ratio?
A debt to credit ratio or a credit utilization ratio is just as it sounds….It’s the ratio of how much money you owe a particular debt as compared to the credit limit. If you have $4,000.00 balance on $10,000.00 credit limit, your debt represents 40% of your credit limit. The lower the ratio or percentage the better impact one’s credit score.
How The Debt to Credit Ratio Affects Your Credit Score
Outside of your payment history, your “amount owed” or debt to credit ratio, is the second highest factor in calculating an estimated 30% your credit score. Keep your balance under the 30% mark and you stay on the lower side of the debt to credit ratio, which is where most personal finance gurus would urge you to stay if you have to carry a balance.
At the same time that my credit card limit jumped up $5,000.00, my balance was quickly decreasing and I had a credit score of 786. The next month it moved up six points and stayed that way for three months. In July, the month I paid off my credit card, it jumped to 806 for about two months. I started using my credit card just a little bit carrying a small balance and it went back down to an 800 for about three months. I was on a high when I saw my score increasing so to see the decrease was disappointing…even if it was only a 6 point drop. I vowed then to do whatever I could to not let my credit card balance roll over to the next month ever again. I am happy to report that I currently have an 810 credit score. Moral of the story… lower your debt to credit ratio and it will have a positive impact on your credit score. You can do this by making on time payments to lower your debt balances and if you are offered a limit increase, take it only if you can continue to be responsible with your financial goals.