Understanding Credit Limits & Debt Utilization
Here’s how your credit limit can impact your credit score…
Most credit cardholders know the repercussions of going over their credit limit - a hefty fee and an elevated interest rate. But, what many people may not know is that just by approaching the limit you can negatively impact your credit score. If the ratio of your credit limit-to-debt (debt utilization) is above 50% you may be considered a higher risk of default. Your debt utilization is a key component of your credit score and is calculated by dividing your outstanding debt by your total credit limit. For example, if you have a $5,000 credit limit and have a $4,000 balance on your account, your debt-to-credit-limit ratio is 80%, indicating that you would be a high risk to lenders and may be too risky to grant any additional credit.
Another measure that lenders use is your aggregate debt, which is simply all outstanding balances added up as reported on your credit reports. If you have an auto loan, a mortgage and a credit card all with balances then your aggregate debt will be the sum of all those balances. Lenders also consider the number of accounts that are being used at one time, not necessarily to calculate your total amount of debt in dollars but to make sure you’re not juggling too many accounts. They take into account not only your revolving credit accounts but your mortgage, car loans, student loans, etc. A potential lender may view a sky-high credit limit as potential debt, which can count against you if you are trying to get a mortgage or car loan.
A 2007 Experian national score index study reported that nearly 14% of Americans have used at least 50% of their available credit balances. Financial experts recommend keeping your debt-to-limit ratio 30% or less. The lower you keep your balances the lower your debt utilization will be and the more positive the impact on your credit score. Ideally, illustrating control and focusing your attention on paying down your debt will send the right signals to lenders and help you secure the credit you need in the future.
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