Your debt to income ratio is a comparison of your monthly debt payments with your monthly gross income. This ratio has an impact on your borrowing power because lenders typically set a cap on this ratio at about 35 percent. If your DTI exceeds this level, you may have trouble getting approval for credit after creditors check your income and debt. If you opt to cancel credit cards to adjust your DTI, proceed cautiously to avoid credit utilization problems. CU is the ratio between the amount of credit you're using and the amount of credit available to you.
Credit Utilization Ratio
The credit utilization ratio is important because it works as an indicator of whether or not you carry too much debt. The lower this ratio, the better your credit score will be. The combined credit utilization ratio for your revolving credit accounts – also known as credit cards – should be lower than 30 percent, states Experian. Where DTI compares your debt service to your income, CU measures how much credit you use out of your available credit. Both ratios provide important information about your financial health.
Do the Math
Calculating your credit utilization ratio is a simple process. Add up the balance you owe for each credit card – this is your total revolving debt. Next, add up your credit limits for each credit card – this is your total available credit. Divide your total debt by your total credit and you’ve got your credit utilization ratio.
Credit Card Concerns
If you find your ratio over 30 percent, it might be wise to make some adjustments, but proceed carefully to avoid disrupting the credit utilization in a different way. Closing credit card accounts will change your debt to credit ratio because it will remove the available credit from this ratio. If you have a debt on a credit card, this ratio change could be especially problematic because closing the credit card account will not remove the debt from your credit score, but it will remove the available credit.
Canceling a Credit Card
As you contemplate closing a credit card, choose carefully to minimize the negative impact to your credit score. Do not choose your oldest credit card, because this card sets the length of your credit history, which is positive for your score, advises TransUnion. Choosing a credit card with a lower credit limit and balance might be most advantageous, if you decide you must cancel a credit card. Many credit card companies require that you pay down any debt prior to canceling a credit card. During this repayment period, you might ask the credit card company to freeze the account to prevent you from using it. Once you pay the balance in full, contact the credit card company directly to cancel it.
- Experian: Balance-to-Limit Ratio Applies Only to Revolving Accounts
- Experian: 5 Ways to Rebuild Your Credit Score
- MyFICO: Will Closing a Credit Card Account Help my FICO Score?
- TransUnion: Closing Bank Accounts and Your Credit Score
- Consumer Finance Protection Bureau: Know Before You Owe
- CreditCards.com: How to Cancel a Credit Card
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