Unfortunately, we generally do not learn about credit — and other personal finance subjects — in school. So when we start “adulting” and embarking on quests like getting our first credit cards or managing credit card debt, such matters can be vague and mysterious to us.
We may have a lot of questions, especially when it comes to the unspoken rules around credit card best practices. One of these questions: How much of your credit card limit should you use?
You may be thinking, “Well, why not use 100% of it; that’s what it’s there for, right?”
There Is a Magic Number
Generally you should not exceed 30% of your credit card limit.
“We all have our own individual financial situations, so the general guideline for credit limits should be to not exceed 30% utilization,” said Mike Dion, founder at F9 Finance. “This means you should keep your balance at or below 30% of your total credit limit across all accounts. Doing this helps maintain a healthy credit score and keeps debt in check.”
Understanding Credit Utilization
Credit utilization is a metric that lenders use to determine how much a consumer can safely borrow.
“It’s the ratio of your outstanding balances to your total available credit limit, accounting for 30% of your FICO score,” Dion said.
This credit utilization metric can heavily impact and shape your credit score.
“A high utilization rate indicates that you may rely too heavily on debt and be overwhelmed with payments,” Dion explained. “If your credit limits are maxed out, lenders might be reluctant to extend any more credit to you. On the other hand, a low utilization rate can improve your chances of being approved for more credit, as it shows lenders that you’re responsible with your money and can manage debt without difficulty.”
People Are Using Credit Cards More Amid Inflation
Now, you also might be wondering: When the economy forces us into tougher times, when we may have no other realistic choice but to rely on credit cards more heavily, can we safely use more of our limit? For example, we know that due to rising inflation rates usage of credit cards has gone way up.
Strangely though, people don’t seem to know just how much more they’re using credit cards.
“Interestingly, consumers may not realize just how significantly inflation has impacted their credit card balances,” said Jenn Schell, a financial researcher and writer for Annuity.org. “A study conducted by Annuity.org found that almost half of participants felt that they used about the same amount of credit as they did before inflation started. These self-reported habits contradict the data provided by the Federal Reserve, suggesting that consumers might underestimate how much more they’re spending on credit as a result of inflation.”
Alas, there is no sort of break that we get cut on using our credit cards more during harder times. So it’s necessary, if you wish to maintain a good credit score, to implement the following credit card habits:
- Strategic Usage: “With rising prices, some consumers may rely more on rewards credit cards, focusing their spending on cards that offer cash back, points or miles to offset the impact of inflation,” said Laurel Gordon, financial expert at Money Bucket. “This strategy can be beneficial if managed carefully; but, if it leads to higher credit utilization, it could negatively affect the credit score.”
- Monitor Your Spending: Track your credit card spending to ensure you’re staying within the 30% utilization ratio. “If you’re approaching the limit,” Gordon said, “consider cutting back on non-essential expenses.”
- Increase Your Credit Limit, If Necessary: One great hack is to request a credit limit increase so you can spend more on your card but still stay within that 30% utilization ratio. “An increased limit can help lower your credit utilization ratio,” Gordon said, “but be cautious not to use the additional credit as an excuse to overspend.”
It’s Especially Important To Pay Down Credit Card Debt Now
In this economic environment, with the Fed dialing up interest rates to help offset inflation, it’s crucial to embrace low credit utilization — again, under 30%, if possible — and to pay down your debts, with the goal of eliminating them entirely.
“As the Fed increases interest rates, borrowers carrying balances on their credit cards will feel the negative impact nationwide,” said Ashley Morris, CFP, director of financial planning at Facet. “Now more than ever, it’s important that borrowers focus on paying off high-interest debt and starting to build savings.”
Though borrowers are negatively affected by rising rates, those using high-yield savings accounts can benefit because they can earn more interest on their nest eggs than in pre-inflation times.
“In 2020, high-yield savings accounts had an average interest rate of 1%, but today’s rates are nearly 4% on average,” Morris said. “For someone with $10,000 saved, that difference translates to roughly $300 of interest earned per year with little to no effort. Talk about a win-win.”
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