Credit Cards

Why Maxing Out a Credit Card Hurts Your Credit

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The term “credit limit” can seem a bit deceiving. If a credit card issuer gives you $1,000 to spend, why is it so bad to actually bump up against that limit?

It can be a bummer to see your credit scores drop because of high debt use, even if you can afford the bills, but it makes sense if you know a little about how credit scores work.

Show You’re Responsible

Your credit utilization rate is one of the most important determining factors of your credit score, because it’s a strong indicator of your financial behavior and how risky it is for lenders to take you on as a borrower.

Credit utilization is calculated by dividing your total outstanding credit card balances by your total available credit on those cards. Keeping your rate below 10% is the best thing you can do for your score in this category, but some experts also cite 30% as the threshold you should aim for.

With that $1,000 credit limit, you’re looking at an ideal balance of $100 or $300, and to get the most out of that limit, you’ll want to pay your balance each month, otherwise it will creep up over time and hurt your utilization ratio.

That may seem simple enough, but you may be wondering, “Why such a low percentage?”

Think about it: Having the ability to spend $1,000 but spending only $100 shows self-control. Lenders are less exposed to losing money when you spend responsibly.

When you filled out your credit card application, the issuer probably asked you to state your income, which is often factored into determining your credit limit upon approval. If you’re getting close to spending what the issuer has determined is the maximum you can afford, potential creditors understandably become concerned that you may be struggling to meet all your financial obligations, since credit allows you to spend now and pay later.

You can see how your credit card spending impacts your credit utilization by checking your scores with the free Credit.com Credit Report Card — it will show you your utilization rate and how it compares to the national average. If you need to improve your utilization, it helps to try and reduce your spending and check your Report Card every month to track your progress.

Work Within Your Limits

As far as budgets go, not everyone with high utilization needs to reduce their spending.

You can always try requesting a credit limit increase, and if that doesn’t work, you can try paying your credit card off multiple times a month instead of just paying off the statement balance to give you more spending room without compromising your utilization rate.

No matter what you can afford, it’s in your best interest to work toward high credit scores, because they will save you money on interest and other loan products.

Image: iStock

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