Have you ever applied for a business loan or any other type of financing? Then you know that your credit score will determine whether or not you’re approved for low-interest rates and favorable terms.
This seemingly innocent number can cause a lot of stress. I know it has stressed me several times in the past. I’ve bitten my nails more than once, hoping my credit score is good enough for a lender.
Many others have spent their nights wondering if their credit score is the reason why they didn’t get that loan they wanted.
But what factors affect a credit score? How can one improve their credit score?
These are questions we’ve all asked before, and while several factors impact your credit score, one of the more important ones is your debt to credit ratio—a ratio that measures how much of your credit is being used.
Let’s take a quick look at how you can calculate your debt to credit ratio to see how it might be impacting your credit score.
What is Debt to Credit Ratio?
Essentially, your debt to credit ratio measures the percentage of the total available revolving credit that you are using. You might also see this referred to as your credit utilization ratio or credit utilization rate.
Revolving credit is credit that resets as you pay off your balance, like with credit cards or lines of credit.
Your debt to credit ratio is significant, as credit score companies weight it very heavily when putting together your credit score.
When you use a large percentage of your available credit, it may lower your credit score as it can be a sign of financial trouble. Alternatively, when you use a low percentage of your available credit and pay it off consistently, you are seen as a responsible borrower, and your credit score will likely improve.
Do not confuse your debt to credit ratio with your debt to income ratio. Your debt to income ratio measures your total debt compared to your income, which is often used by lenders to determine whether or not you are a high-risk borrower.
Generally speaking, you should aim for a credit utilization ratio of below 30%. A higher ratio than this might lead to a lower credit score, which can make it challenging to apply for small business loans.
How to Calculate Your Debt to Credit Ratio
Want to check your credit utilization ratio to see how it might be impacting your credit score? Fortunately, calculating your debt to credit ratio is extremely easy.
The formula for calculating your debt to credit ratio is as follows:
Debt to Credit Ratio = (Total Balance ➗ Total Available Credit) ✖️ 100
Total balance is the sum of the balances you currently have on each of your credit cards or other revolving lines of credit.
Your total available credit is the sum of the credit limits on each line of credit.
Alternatively, you can calculate your per-card debt to credit ratio. In this case, the formula is the same; however, instead of using total balance and total available credit, you would just use the balance and credit limit for the one credit card.
What Does My Debt to Credit Ratio Mean?
Knowing how to calculate your debt to credit ratio is excellent, but it’s useless if you don’t know what to do with this information.
Using the formula, you’ll get your debt to credit ratio in the form of a percentage. But what does this percentage mean?
Well, simply enough, this percentage is the portion of your available credit that you use. So, for example, if your debt to credit ratio is 40%, that means you utilize 40% of your credit limit.
Like I mentioned earlier, a good rule of thumb is to aim for a credit utilization rate of 30% or lower. When your ratio is higher than this, it not only lowers your credit score, but it can give lenders the impression that you are an irresponsible or high-risk borrower.
For business owners, this can hurt your chances of being approved for the financing you need to help grow your business.
If your debt to credit ratio is too high, you may need to work on lowering it before you apply for a business loan or choose a lender with more lenient requirements, like Camino Financial.
Debt to Credit Ratio: In Real Life
Let’s take a quick look at how you might be able to use the debt to credit ratio formula in real life to assess your financial wellbeing.
Say you have three credit cards with credit limits of $1,000, $3,000, and $5,000 ($9,000 in total).
Let’s also say that you are carrying balances of $500, $1,200, and $2,000 on each of these cards, respectively ($3,700 in total).
To calculate your debt to credit ratio, you would use the following formula:
Debt to Credit Ratio = (3,700 ➗ 9,000) ✖️ 100 = 41.11%
In this instance, you would have a credit utilization rate of 41.11%. Since under 30% is ideal, you might want to consider lowering your debt to credit ratio by using less credit, increasing your total available credit limit, or practicing better debt management.
If you want to calculate your per-card credit utilization ratio, use the same formula with the numbers from only one credit card.
So, for example, if you have a credit limit of $2,500 and a credit card balance of $1,000, your debt to credit ratio would be:
Debt to Credit Ratio = (500 ➗ 2,500) ✖️ 100 = 20%
In this case, 20% is a very reasonable debt to credit ratio, so you don’t necessarily need to worry about adjusting your spending habits.
It’s Important to Have a Healthy Debt to Credit Ratio
Debt to credit ratio is one of the most critical factors used to determine your credit score. By using the formula provided in this article, you can quickly and easily calculate your credit utilization rate and use this information to adjust your spending practices as needed.
By improving your debt to credit ratio and your credit score, you can qualify for small business loans with great rates and terms.
At Camino Financial, we operate on the motto, “No Business Left Behind.” That’s why we offer small business loans with lenient requirements, competitive rates, and excellent terms. Our loans will help you reach success.
Want to learn more?
Request a quote for a business loan today to see how we can help you grow your small business.