Credit cards offer incredible convenience for users, and remain one of the most popular methods that consumers use for spending of all kinds. When managed effectively and paid off diligently, there’s nothing wrong with using credit, even across multiple cards, to manage your finances: there’s even a host of benefits and perks to take advantage of, such as travel rewards or cash back incentives. However, there are pitfalls and perils to avoid, not the least of which is a maxed out card.
When you apply for a credit card, your spending limit is determined largely by your credit history. The more responsible you’ve been with your credit in the past – for example, keeping your bills paid up on time – the more likely it is that you might be offered a higher limit. And you’re always aware of what that limit is. So, why is it that so many people are driving dangerously up to the maximum on so many cards? The very ease of use and convenience of credit cards also makes them somewhat dangerous, especially for those people who haven’t taken the time to plan and evaluate their spending patterns.
Cards and Scores
A large part of your credit score – up to 30% – is based on how much of your available credit you’re using. This ratio of credit card balances to credit limits is known as your credit utilization. The higher your credit utilization, or the closer your credit card balances are to your credit limit, the more your credit score is hurt. Maxing out a card means you’re using 100% of that card’s capacity! If it’s your only card, it will have a significant negative effect on your overall credit score, which will hurt your ability to benefit from many other important financial processes and instruments, like loans.
It may sound like the easiest thing to do is simply apply for another card and start from 0% on that new one, but this plan of action only digs the damage in deeper and makes things worse.
Paying the Penalty
Most credit card issuers have a “penalty rate” for those who go over their credit limits. This interest rate can be astronomically high, in some cases 30% or greater. If you’ve hit your limit on a card with a $1000 limit, you’re adding $300 in penalties each month that it goes unpaid! This can have disastrous consequences for your finances. The increased squeeze on your budget needed to pay off the penalty means that it’s likely that you may only be able to pay smaller and smaller increments to the issuer each month, which means you’re penalized for even longer, which means the penalty cost only gets bigger… it’s a devastating cycle, and one that needs to be avoided at all costs.
As a last resort, credit card issuers may flag the accounts of users who have maxed out a card. If you hit the limit once or make a significantly larger than average purchase, you may get a call from your issuer expressing concern. Max out repeatedly, and you risk them cancelling your card outright. Unfortunately, you’re still responsible for the balance and any penalties owed, however.
It’s important to know the limits of your cards and respect them. Just because you have been allowed a certain amount of credit doesn’t mean that it’s financially responsible or safe to use the entirety of it. It’s like looking at a beautiful vista overhanging the ocean: you want to appreciate what it has to offer, but don’t tiptoe on the edge of the cliff.