Q. How is the income-to-debt ratio figured? When I make a large purchase with a credit card, I sometimes pay it in two payments, one right away and the second by the end of the billing cycle. Does the mid-cycle payment reduce the ratio for the month? Does it improve the credit rating?
— Credit concerned
A. It is always good to know what your credit score is and how it can be improved.
It’s the key to interest rates on consumer loans, insurance premiums, cell phone plans and even the ability to rent an apartment.
Making payments on time and keeping credit card usage well below the limit will have a positive impact on the two largest factors that influence a credit score, said Claudia Mott, a certified financial planner with Epona Financial Solutions in Basking Ridge.
Each individual’s credit score is calculated based on the five components: 35% payment history, 30% amount owed, 15% length of credit history, 10% credit mix and 10% new credit.
The debt ratio you are referring to is known as a “credit utilization ratio” or “CUR.”
It is calculated by comparing the credit limit on revolving credit cards to the outstanding balance, Mott said.
“A CUR under 7% is a very good ratio and will favorably impact an individual’s credit score,” she said. “A ratio between 10 and 20% is deemed acceptable, while anything exceeding 30% will negatively affect a credit score.”
Mott said the calculation of the ratio takes into account both the amount you owe on individual cards and how the outstanding balance compares to the overall credit limit — with the latter being the more important input.
“Generally speaking, your lenders report outstanding balances at the end of the billing cycle, but the timing of this may not coincide with the credit bureaus monthly update of your score,” she said. “The mid-month payments you are making should help improve your credit utilization ratio by reducing the balance outstanding and this may result in a lower credit score for that time period.”
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Karin Price Mueller writes the Bamboozled column for NJ Advance Media and is the founder of NJMoneyHelp.com. Follow NJMoneyHelp on Twitter @NJMoneyHelp. Find NJMoneyHelp on Facebook. Sign up for NJMoneyHelp.com’s weekly e-newsletter.