Debt-To-Limit Ratio
Every credit card has a limit. Most of us grok this fact all too well, as we clumsily fumble through pocket change to pay for a convenience store hot dog a week after coming home from that Bermuda vacation. Others of us have never sniffed the limit on our special-issue jet-black card that came special delivery in a gold-trimmed velvet box. Now that we think of it, those cards might not have limits. But take our word for it, most cards have limits. (You can't buy a country with the jet-black card...we think.)
The relationship between the amount of money you've spent on the card and its spending limit provides the debt-to-limit ratio. Basically, it answers the question "how much of your borrowing capacity have you used?"
Credit tracking companies use this number to figure out your credit score. If you're maxed out on your credit limits, you're seen as a bigger credit risk and your score will go down.
This relationship leads to a situation that sometimes confuses consumers: it's better for your credit score to have a lot of credit cards that you don't use, rather than to close those cards permanently. Having those unused cards increases your overall limit, making your debt-to-limit ratio lower.
Related or Semi-related Video
Finance: What is Debt-to-EBITDA?58 Views
finance a la shmoop what is the debt to EBITDA ratio alright people well
anytime you see that to in there a pretty good chance we're dealing with a [Person writes ratio on chalkboard]
ratio and yeah this one's a ratio that compares what a company owes in debt to
its EBITDA or earnings before interest taxes depreciation and amortization
otherwise lovingly known on Wall Street as cash flow like the cash it produces [Cash falls from sky]
alright well the numbers used by bankers and investors to see how leveraged is a
company is and evaluate its creditworthiness the higher the number
the more likely it is that a company will struggle to pay up its debt.. Well,
let's use a couple of practical examples here, a demo;
if your friend Deb wants
to borrow five grand from you maybe Deb just doesn't want her pops to
know she you know dented the car she's not the best driver in the world and
Deb's a two on the friend reliability scale like you totally trust her and [Deb moving side to side on reliability scale]
she's a lawyer and makes hundreds of thousands of dollars a year suing people
for stuff all right well after living expenses she has cash flow personally of
some fifty grand a year that she socks away in a mattress you know what she [Deb places cash under mattress]
sleeps on so you'd go ahead and make the loan to Deborah and you'd have no doubt
that she has the dough to pay you back your five grand the debt to EBITDA in
this situation five grand over 50 grand or one to ten or 0.1 very low debt to
EBITDA ratio there very safe bet she'll pay you back your five grand
well this logic applies to loaning companies money as well the five grand [Man discussing loans outside Amazon building]
in debt is quote money good unquote and you don't lose sleep over loaning them
that money if they have good credit and low debt to EBITDA doubt ratios right they
have more than enough cash flow to cover that debt well so then what's bad debt
to EBITDA ratio like what does that look like well it's when you have debt
of more than three or four five times cash flow some companies go even higher [Bad debt-to-EBITDA ratio example]
so if whatever dot-com has 50 million dollars in cash flow but three hundred
million dollars in debt that's a really high debt to EBITDA ratio of three
hundred over fifty or six to one or you just say
6x if that debt costs a 8% a year to rent well then the total cost just to pay
interest is 24 mil or almost half of all the company's cash flow for the entire
company and remember they got to be paying down the principal as they go [Whatever.com's cash flow debt]
along as well so it's a huge percentage of their cash flow just goes to the bank
should whatever com stumble and maybe you don't know interest rates go up as
well well then things could get ugly really fast and yes even uglier than [Deb driving a car in a storm]
this so yeah you want low debt to EBITDA ratios not high ones unless you're a
real dice roller there [Debt laid in hospital bed]
Up Next
What is the Debt-to-Equity Ratio? Debt to Equity ratio is a metric used to determine the degree of financial leverage a company has. The formula is...