Credit Corner: Key Rates and Ratios, Simplified
Interest rates aren't the only numbers you should be interested in.
When it comes to credit, it can be hard to get all the rates and ratios right. Interest rates, the cost of what you're borrowing expressed as a percentage of the amount you're borrowing, may be the most commonly understood figures. Here are 3 more you may have seen or heard, but not fully understood.
Ever wonder what APR means? It stands for Annual Percentage Rate, and it's a figure that helps you understand the total cost of your loan. Like interest rates, it's expressed as a percentage.
How are APRs different than interest rates? An APR takes the interest rate into account, but also factors in any fees, finance charges and other loan costs, wrapping it all back up as a percentage amount you'll owe on a yearly basis.
2. Credit Utilization Rate.
Generally speaking, your credit utilization rate is also expressed as a percentage — it's the amount of credit you're using compared to the amount of credit you have available.
For example, let's say you have 2 credit cards. You owe $1000 on one card, which has a credit limit of $10,000. You owe $2000 on the other card, which has a credit limit of $5,000. Typically, your utilization rate will add up what you owe and divide it by your added-up credit limits. So, in this example, your utilization rate will be: $3000/$15,000, which comes out to 0.2 and will be expressed as 20%.
Lenders and creditors may use a borrower's utilization rate to evaluate their creditworthiness. Generally, the higher the utilization rate, the riskier the borrower is typically seen.
3. Debt-to-Income Ratio
Debt-to-income ratios may also be used by lenders or creditors to evaluate a borrower's ability to handle more debt. Simply put, it's your total debt divided by your income. So, if your total debt amount is $5,000 and your annual income is $50,000, your debt-to-income ratio is 10%. Generally, the higher your debt-to-income ratio, the riskier you appear to lenders or creditors.
Now that you know more about these 3 rates and ratios, the key is to use them to understand debt you're considering taking on or debt you currently owe. The more you know about these and other calculations, the better you may be able to understand which kinds of debt and how much debt makes sense for you.