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Understand Your Credit-to-Debt Ratio

Another way to improve your credit score is by improving your Credit-to-Debt Ratio. What does it mean when you close credit card accounts and how does that affect your FICO score? Is it true that if you close credit card accounts you no longer use it improves your FICO score?

Your Credit-to-Debt Ratio affects your credit score.  It is calculated by dividing your debt by your available credit.

Not true! When you close an account that was in good standing, your credit history for that account is closed too. Yes, it still shows up on your credit report, however, that “good history” will no longer be included in the calculation of your FICO score.

Balance Transfer Credit Cards

Don't consolidate all of your credit card debt into one low-rate credit card and close the other credit card accounts. When you do this, this does a couple of things that can hurt your credit:

  • It reduces your total credit limit

  • It frequently means you are closing accounts that have been open a long time. Credit bureaus want to see a long history of on time payments. The longevity you had with your accounts will help your credit score.

Instead, if you reduce your credit card balances on these accounts it can help boost your credit score. Also, when you carry a balance, try to keep the balance less than 40% of the credit limit. The higher your monthly balance, the more it appears as though you are unable to pay off your debts.

At the very least, if you open a balance transfer credit card, keep the original accounts open.

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Credit-to-Debt Ratio is calculated as follows:

Debt Used ÷ Available Credit = Credit-to-Debt Ratio

Here’s an example:

Debt Charged Available Credit (Credit Limit) Credit-to-Debt Ratio
$1,000 $5,000 20% (good)
$2,500 $5,000 50% (not very good)
$10,000 $10,000 100% (maxed out)

Based on this information, banks and other financial institutions can see just how close to being in financial trouble you are. If you have a low debt ratio, the grade will be higher. Conversely, if a borrower has a high debt ratio, the grade will be lower. Pretty simple.

This debt to credit ratio is also used in the calculation of your FICO score. Therefore, the higher your debt ratio to the available credit, the lower your FICO score will be. If you can keep your debt load under 50%, you will be better off.

Don't Close a Paid Off Account

So remember, when you consider the above, you can see why it isn’t a good idea to close a paid off account:

  1. It closes the good history on the account

  2. It reduces the available credit and increases the debt ratio

Click to find out how to get your free credit report.

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