Americans have many financial myths. Some have traces of truth while others are totally false. An all-time favorite myth is about feeling an itch on your palm, it’s supposed to indicate that some cash is headed your way.
We all know that’s not true. But there are people who could swear that it’s true.
Several other myths surround our finances, especially concerning credit cards and credit scores.
Many people falsely believe that credit cards are sheer evil and getting a credit card is a one-way ticket to unending debt cycle.
Again, that’s not true! On the contrary, there are major downsides of not having a credit card.
Another common belief concerning credit cards is that you should never charge anywhere close to the limit. In fact, some people have come up with a rule. The 30 percent credit utilization rule.
All these opinions can leave you bewildered.
We all want an excellent credit score. However, restraining yourself to just 30 percent of your credit limit sounds a little restrictive. After all, there’s an entire 70 percent of an unused credit line.
The central question is, how much of your credit limit can you use and stay safe?
We’ve put together information that’ll enlighten you about your credit limit and what influences it as well as your credit utilization ratio, how to calculate it and what ratio you should aim for.
What is Your Credit Limit?
Whenever we hear about limits, we often think about restrictions and boundaries. The same applies to the credit limit.
When you apply for a credit card, essentially you are borrowing money.
Approval for a credit card means the lender is willing to extend to you the facility and the credit card limit is simply the lender’s way of saying, “You can borrow but only up to this much.”
It is the maximum you can charge on a card within a specified period.
To find out what your credit card limit is, simply scrutinize your credit card statement or check out your online account. If you are still having some trouble with that, you can call the number on the back side of your credit card and seek assistance from your provider.
Why is your Credit Limit Important?
Your credit limit is an indication of how creditworthy you are. It’s a signal (not the only one) of how much lenders are willing to entrust to you.
This obviously means that your credit limit determines your credit score and the opposite also applies.
Having a good credit score can affect your credit limit, which affects how well you can access other loans such as mortgages and car loans as well as where you stay and your job prospects.
Having an excellent credit score is a big deal!
You can read this article and find out more about your credit score, what affects it and how to build a good credit score.
Before we see how much of your credit limit should you use, let’s dive in a little deeper and see what else influences your credit card limit.
What influences your credit card limit?
In addition to your credit score, there are other aspects that influence your credit card limit. Here are the top three factors.
1. The Kind of Credit Card
Credit card companies have unique products that fit particular markets. Some cards have predefined features such as the interest rate and credit limit.
For example, a credit card issuer could have a special credit card for students and cap the card limit of such a product to say $ 1,000. Also, the limit of a secured credit card is determined by the value of the security held.
Predefined limit credit cards are popular for secondary cardholders. For instance, parents who want to give their children some freedom with credit cards, and other clients considered to be “green.”
Some card issuers offer a range of limits for particular card types, say limits extending from $ 5,000 to $10,000. Here, the most qualified clients get the highest limit while other clients are accorded lower limits in line with their qualification. A fine example is the Chase cards range. You have the choice of picking between Chase Freedom, and Chase Sapphire options.
If you feel that a capped credit limit card or a secured card sounds like a good idea for you or your spouse or kids, reach out to First Progress Secured Credit Cards. You can pick from either of the Platinum Elite MasterCard®, Platinum Select MasterCard®, or Platinum Prestige Card options®.
How much you earn significantly influences your credit card limit.
Like we mentioned, credit card issuers are simply lenders and they reckon that the more you earn, the more disposable cash you have and can spend.
So, chances are high that you could get approved for a higher credit card limit if your income is high. However, this is not a guarantee. Other factors, most notably your debt-to-income ratio, will influence that decision.
3. Debt-To-Income Ratio
Your debt-to-income ratio shows how much of your income is available to pay debts.
This is usually calculated as a fraction of your income that remains and is available for repaying credit card bills after deducting all your existing debt and statutory obligations.
This means that you could be earning a high income, however, if your existing debt and statutory obligations are high, what is available to pay the credit card bills remains low. Thus your credit limit will be lower than your income would otherwise command.
You can read this article and find out how you can pay off debt fast and improve your debt-to-income ratio.
There are other factors which influence your credit card limit including your credit history, the limits you have on existing cards and other special conditions that the card issuer may set on a particular product.
What is credit utilization or credit utilization ratio?
Now that we’re clear on credit limit and what affects it, let’s see how much you can use. In other words credit utilization or credit utilization ratio.
Credit utilization ratio simply describes the portion of credit you are using as a fraction of the maximum permitted credit line.
You can say that it’s an expression of your average total balances against your credit limit.
For instance, if you have a limit of say $ 1,000 on your card and you are carrying an average balance of $ 280, your credit utilization ratio is 28 percent. If you have 10 cards, each with a limit of $ 1,000 and your average balance is 280, per billing cycle, your utilization ratio is the average balance divided by the combined limits. In this case, it is still 28 percent.
Lenders frequently use your utilization ratio to calculate your credit limit and yes, it also affects your credit score.
Now to the big question; how much of your credit limit should you use? In other words, what credit utilization ratio should you target to maintain an excellent credit score?
What credit Utilization ratio should you target?
There are no hard rules on what is the optimum ratio. However, many financial advisors will inform you that you should aim for a score not higher than 30 percent.
Credit utilization is second only to your repayment history when it comes to calculating your credit score.
A lower utilization indicates a lower credit risk. Therefore, a lower utilization may translate to a higher credit score.
However, a very low utilization ratio may not be beneficial for you. It simply means that you can’t capitalize on an elaborate repayment history, which is the most significant aspect of calculating your credit score.
On the other hand, a high utilization ratio is a typical indicator of higher credit risk, thus a lower credit score. But, it gives you an opportunity to capitalize on repayment history and build your credit score.
Some financial advisors say that you can stretch your credit utilization ratio without affecting your credit score significantly.
If for instance, you increased your utilization from 29 percent to 31 percent, your credit score won’t just drop like a cliff. It’s more like a sliding scale. Other factors will come into play and gradually shift your score.
In order to maintain an excellent credit score, you have to be really meticulous on the billing date, charge date, your balances, and the billing cycle, and make on-time payments.
That’s too much to keep track of.
Experian conducted a survey in 2017 and found out that the average American credit utilization ratio is 30 percent. However, millennials and Gen-Xers had a slightly higher utilization ratio and they attributed this to the resultant lower credit scores.
Financial advisors from Experian and FICO advice that a safe ratio should be between 10 percent and 20 percent. 10 percent for a conservative approach and 20 percent for a “safe” utilization.
But the bottom line is that there are no hard rules prescribing an optimum credit utilization ratio.
Therefore, your pick is as good as mine.
What would happen if you hit, or exceeded your limit?
What if you charged too much on your credit card and exceeded the recommended 30 percent utilization ratio. Or what if you hit 100 percent and exceeded it?
Your credit score will take a hit. But as we mentioned, it won’t be an abrupt drop. Other factors will come into play and eat into those hard earned points.
Remember, it’s a sliding scale, not a sharp cliff.
Moreover, if you hit or exceed your credit limit, you’d have to contend with nasty fees and exorbitant interest rates ultimately affecting your credit score negatively.
So, it is vital to know and keep tabs with your credit limit and your utilization ratio.
The next obvious question is how can you maintain a low, or optimum credit utilization ratio?
How to Reduce and Maintain a Low Credit Utilization Ratio
Since it’s a ratio, there are two options for reducing your utilization or and maintaining a low ratio.
Either reduce the average amount you charge to credit cards per billing cycle, or talk with your credit card issuer and increase the credit line. That’s your credit limit.
If you prefer the latter option, watch out so that you don’t lose control of your spending habits and end up in a debt tailspin.
Better still, you can do both and maintain safe credit utilization ratio.
To conclude, if you’ve been wondering, how much of your credit limit should you use? Remember that there are no hard rules or a magic credit utilization ratio figure. Also, greater utilization indicates a higher credit risk. Therefore, avoid hitting or exceeding your limit at all costs.