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You probably already know that going over your credit limit can be a disadvantageous proposition: You’ll face very expensive fees, higher interest rates, and possibly a lower credit score. But you might not be aware that getting close to your limit can also be a bad thing. Why? Because your debt utilization (commonly referred to as your “debt-to-credit-limit ratio”) is a major part of your credit score. It is calculated by dividing the amount you spend by your total credit limit.
Let’s say your credit limit is $10,000 and you’ve charged $9,000. This gives mortgage lenders a signal that you are a borrower they consider to be in a high-risk category – which is definitely not good. What can happen is that the lender may increase your Annual Percentage Rate (APR). Or, worse, deny you a loan—even though you pay your credit card balance in full each month and have never exceeded your credit limit. So what should you do to avoid getting into this situation? Be wise and follow the advice of the experts: Make it a serious goal to keep your debt-to-credit limit ratio below 30% — or even 10%.
What else don’t you know about your credit limit? View your monthly credit card bill; You already know that its your credit limit. However, did you know that your limit can change from one billing cycle to another? This is because credit card issuers can increase or decrease your limit whenever they want. Sure, they have the right to determine what your credit limit is. But as a consumer, you have the right to request that they increase your limit. Remember, the more available credit you have, the better your debt-to-credit ratio. Just keep in mind that your credit card issuer may be willing to increase your limit if you have a good credit history – but if your history isn’t so warm, they’re likely to say “no”. While this may be frustrating for you, please try to see it as a blessing in disguise. It’s actually a piece of wise financial advice: It’s telling you to reduce your spending, or pay off your credit card balances, or both. And here are two more reasons why you should be thankful you don’t get a higher credit limit:
1. If you’re a “spender” and you’re easily tempted to buy more than you can afford, a high credit card limit can trap you in a financially unhealthy debt cycle.
2. It is possible that potential lenders will perceive a very high credit limit as “potential” debt – this may count against you if you are trying to get a mortgage loan.
What other choices and decisions could make a difference, either negatively or positively?
1. If you think signing up for a new credit card will increase your available credit and decrease your debt utilization, think again. This can work against you—and even lower your credit score.
2. Do not inquire about opening new credit card accounts. Recent credit inquiries are 10% of your credit score. So each one means that the possible number of points can be subtracted from your score.
3. Closing unused credit card accounts is not a good idea. This is because the total amount of your available credit decreases. In turn, this can increase your loan utilization and lower your credit score.
4. Use the old credit card from time to time for small purchases (such as a tank of gas or a meal at a moderately priced restaurant) – then pay the balance in full when you get the bill. This will prevent the credit card issuer from closing the account due to inactivity.
So…borrowed or own? this is up to you. Because basically, it’s about how you handle debt. If you treat your credit in a responsible and knowledgeable manner, you will be rewarded when it comes time to make the life-defining financial decision of buying a home.
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