What is the Debt to Credit ratio?

As promised yesterday, the debt-to-credit ratio is something that anyone looking to improve their credit score should pay attention to. Let me paint you a small picture to help explain.

A young man goes off to college and has a credit card or two that are worth around, lets say, $2,000 total. After many years and a great deal of hard work this man graduates with a Bachelors and a Masters. Along with two diplomas. He also has $100,000 in student loan debt. And yes, that is, and was, his Piper and how his Piper grew his Wave.

So, now the man has a 98% debt-to-credit ratio, and this is not a good thing.

While the exact way that the FICO score is calculated is an ever changing, closely guarded secret, the debt-to-credit ratio plays as much of a 30% role in determining an individuals score. The reason being, or at least a number of books and websites have stated, that if this man was to be given a higher score, he would be able to gain more credit, and could use that credit to dig his debt hole even deeper.

Okay, so how do you fix this?

Well, basically you need to work it from both ends. If we continue to use this man as an example, the recommendation would be to pay down his debt as quickly as is possible (and we all know how easy that is, yeah right). But it is also important to start increasing your amount of available credit. Now, let's say that this man has a poor credit rating, and can not get approved for any credit cards of any limit, well the good news is he still has options.

One of the better options is what is known, or at least I know it, as a Secure Card. This is a card that you pay the money for a desired credit limit for up front. In this scenario let's say the man signs up for a secure card worth $500. With this he has done two things. First, he has established an additional $500 of credit, and raised his available credit to $2,500. Second, he now has another card reporting to the credit agencies each month, and as long as he is on-time with payments he is building a long, perfect, credit history, which carries a good deal of weight as well.

So, now, just like with savings, he wants to put more money into that card each month to raise the limit. If he puts in $100 for 2-years and pays off $10,000 of his debt, his available credit is now $3,700, and his debt is $90,000. This will give him a debt-to-credit ratio of 95.9%, which while it does not seem like a tremendous jump, it will help his credit score. After maybe another two or three years of this the ratio gets better, and so does his credit score.

This combined with everything we talked about yesterday, Five Ways to Immediately Improve Your Credit Score, will allow the man to apply for and most likely receive credit without having to go into his own pocket.

Sure, this may look like a long way to go, but remember that the debt-to-credit ratio is valued around 30% of your calculated credit score. So, if you were to get this into a better range you would be making a bigger impact.

Is this something you all see as helpful, or something you already knew?

As always, thank you...The Runner