Debt-to-Limit Ratio: Meaning, Impact, Example

What Is the Debt-to-Limit Ratio?

The debt-to-limit ratio is a metric used to assess the creditworthiness of a borrower. It is calculated by dividing the borrower's total outstanding revolving debt (such as on their credit cards) by the total amount of credit available to them. For example, a borrower with $5,000 in credit card debt and a total credit limit of $10,000 on all of their cards combined, would have a debt-to-limit ratio of 50%.

How the Debt-to-Limit Ratio Works

The debt-to-limit ratio has several other names, including balance-to-limit ratio, debt-to-credit ratio, and credit utilization ratio. In all cases, it compares the total amount of revolving debt a person has outstanding at a particular time to the total amount of revolving credit they have available to draw on, expressed as a percentage. It does not consider installment debt, such car loans and mortgages.

Regardless of the name it goes by, the purpose is the same: estimating how close the borrower is to "maxing out" their credit-bearing capacity. In general, a debt-to-limit ratio of 30% or less is considered acceptable by most lenders, while ratios above that level will start to prompt concerns that the borrower may be overextended.

Another common metric, debt-to-income ratio, or DTI, takes different variables into account. Rather than just revolving debt, it also includes installment debts, comparing the person's total monthly debt obligations to their gross income per month. Lenders may take both a prospective borrower's debt-to-limit and debt-to-income ratios into account in deciding whether to grant them a loan or other form of credit. However, unlike their debt-to-limit ratio, a person's debt-to-income ratio doesn't figure into their credit score. That's because the credit reports on which credit scores are based do not include information on the subject's income.

How Debt-to-Limit Ratios Affect Credit Scores

Consumers' credit scores are based on a number of factors, each of which is assigned a weighting according to its importance.

In the most widely used credit scoring model, FICO scores, payment history—basically whether the person has paid their credit bills on time each month—counts for the most, with a weighting of 35%. Next comes what FICO calls "amounts owed," at 30%. A key factor in that category is the individual's debt-to-limit, or credit utilization, ratio. A high ratio can have a negative effect on their credit score, while a lower ratio can have a positive one. However, the company behind FICO scores notes, "In some cases, a low credit utilization ratio will have a more positive impact on your FICO Scores than not using any of your available credit at all."

Real-World Example of a Debt-to-Limit Ratio

Emma is considering applying for a mortgage. To see where she stands, she obtains both her credit reports and her credit score—which turns out to be lower than she expected. When reading through her credit reports, Emma discovers that her score was negatively affected by her debt-to-limit ratio.

At 50%, Emma’s debt-to-limit ratio is above the 30% threshold that is generally considered acceptable by most lenders. To help improve her credit score, she decides to take active measures to lower that ratio. First, she reworks her budget so that she can pay off a greater portion of her outstanding debt each month. She also applies for credit limit increases on her current credit cards, so that her outstanding debts will shrink relative to her new total credit limits.

Emma might also consider applying for an additional credit card to increase her total credit limit. A balance transfer credit card that charges low or 0% interest for an introductory period could allow her to consolidate her existing debts on that card and pay them off more quickly.

The Bottom Line

Your debt-to-limit ratio is an important number in calculating your credit score. If it is not as good as you'd like it to be, there are ways to improve it.