Finance Globe

U.S. financial and economic topics from several finance writers.
3 minutes reading time (638 words)

Big Balances Can Be Big Trouble

Credit limits can be deceiving. While they do represent the maximum amount your credit card issuer will let you charge, it’s not necessarily the amount you should charge. In fact, your credit card balance should never meet, and certainly not exceed, your credit limit. Having a big balance on your credit card is risky.

Repayment Difficulties

One of the most important rules of using a credit card is that you should never charge more than you can afford to repay. Ideally, you should be able to pay your balance in full each time your statement comes. If you create a big balance, it’ll be much harder to pay off all at once. Instead, you may have to make monthly payments to get rid of the balance. In the meantime, you’ll have to have enough discipline not to make more charges on your card.

Risk of Debt

Several large credit card balances could signal looming financial trouble. How so? Large credit card balances also come with large minimum payments – the amount you have to make to keep your credit card in good standing and avoid severe penalties. Unfortunately, the minimum payments on big balances could create financial strain. If your monthly minimum payments are above 7% of your monthly income, you should do something immediately to keep the situation from worsening.

High Finance Charges

The bigger your credit card balance, the more interest you’ll pay repay your balance over time versus paying it in full at once. That’s because monthly finance charges are calculated as a percentage of your credit card balance. The bigger the balance, the higher your finance charge will be.

Minimizing finance charges is important for two reasons. First, avoiding finance charges is being sure you're not wasting money. All you get in exchange for the finance charge is the convenience of paying your balance over time. There’s no tangible benefit for the money you spend. Second, a portion of your monthly payments goes toward finance charges and it takes longer to pay off your account. If you keep your balance low enough, you can pay it in full and avoid finance charges completely.

Damage to Credit Rating

The second most important factor influencing your credit score is the amount of debt you have. The higher your credit card balance, relative to your credit limit, the more your credit score will be affected. Keeping your credit card balance below 30% of the credit limit is good, below 10% is even better to protect your credit score.

Credit card issuers can cut your credit limit at any time. If you have a big balance, the lower credit limit could impact your credit score. That’s another good reason to keep the balance low: just in case the credit card issuer reins in your available credit.

Difficulty Getting Approved

Other creditors and lenders don’t particularly like it when applicants have big credit card balances. It could indicate that you have more debt than you can handle. Or that you can’t afford a new credit card or loan because so much of your income is dedicated to the big balances you already have. You may not plan to apply for credit or loans in the near future, but when you do get ready to put in an application, having your balances low will help your chances of getting approved.

Keeping your balances low requires self-discipline. It’s good to know your credit card issuer’s credit limit, but give yourself a “soft” credit limit that’s 30% of your limit or less, e.g. $300 on a card with a $1,000 credit limit. Aim to keep your balances below their “soft” limits. If your balances start getting out of control, stop charging and pay them down. Not will it reduce the risk of debt, it will also help build a great credit score.
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Saturday, 04 February 2023

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