When you go in search of debt advice, you have to know your current status. Your debt to income ratio and credit usage ratio shows you where you are and help you track your progress.
How much debt is enough and how much is too much? That is really the same as the proverbial question about how long a piece of string is. The answer depends on so many things.
Fortunately, your finances are not a piece of string and you can answer the question about debt with two simple calculations. They are your debt to income ratio and your debt usage ratio, and you should use them both to track your credit wellness.
Debt to income ratio (DTI)
Your debt to income ratio shows how much of your income you spend on servicing your debt, and is an excellent credit monitoring tool
Here’s how to calculate it:
All your debts DIVIDED BY your gross income x 100 = debt to income ratio (DTI)
- Gross income is all the money that comes in every month before deductions like tax.
- Debts are all your loans or accounts (including rent or home loan, car loan, clothing accounts, cell phone contract, credit card debt) and other fixed obligations, such as child support and utilities.
Example Joe earns R12 350 per month Joe’s debts are R6 820 per month Joe’s DTI: 6 820 ÷ 12 350 x 100 = 55,2% Joe spends way too much of his income on paying off debts.
A healthy DTI is between 28% and 36%.
Your DTI matters because:
- It shows you how much breathing space you have to deal with life’s surprises, and helps you make decisions about how to spend your money.
- When you apply for credit, it tells the credit provider how risky it is to lend you money.
How to improve your DTI:
- Increase the amount you pay on your debt.
- Don’t take on more debt.
- Work out your DTI every month to track your progress.
Debt usage ratio
Your debt usage ratio shows how much of the credit available to you, you are currently using. This only applies to so-called revolving credit, which are things like credit cards, store cards and an overdraft on your bank account. It is called revolving credit because as you spend and repay, the credit becomes available again. In other words, every time you settle your credit card balance, you can spend on the card again.
Here’s how to calculate your debt usage ratio:
- Add up the credit limit on all your cards
- Add up the outstanding balance on all your cards
- Your total balance DIVIDED BY your total credit limit x 100 = your debt usage ratio
Example Nomsa has a credit card and two store cards. The combined credit limit on the three cards is R17 000. At the moment, she owes a total of R14 325.15 on the three cards. 14 325.15 ÷ 17 000 x 100 = 84.4% Nomsa is using far too much of her available credit.
A healthy credit usage score is between 30% and 35%. However, according to the credit bureau Experian, consumers with the best credit score – around 800 – usually keep their usage at about 7%.
Your credit usage ratio matters because:
- It makes up about one-third of your overall credit score on your credit health report. If you use too much debt, your credit score will be poor even if you never miss a payment.
- A low credit usage ratio shows that you are doing a good job of managing your credit by not overspending. This will make it easier for you to get a new loan when you need one.
How to improve your credit usage ratio:
- The best thing you can do is to pay your card balances in full every month. Even if you cannot get back to zero every month, keeping your balances as low as possible will help you move in the right direction.
- Stop using your cards until your credit usage ratio is back under control.
- Do not use one card to pay another card’s instalment. Your overall ratio will remain exactly the same and you won’t improve your credit wellness.
- Set yourself a target and calculate your credit usage ratio every month to track your progress.
When you can measure something, you can track and improve it. With your DTI and credit usage numbers at your fingertips, you are on your way to credit health.