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Why you should never max out your credit cards?

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Credit cards come with a credit limit and it is the maximum amount that you can spend on your card. In order to maintain a lower credit utilization ratio, you should keep your credit card balances well below this limit. And when you use up the entire limit available to you, or are very close to exhausting the limit, your card is maxed-out. So, if your total credit card limit is Rs. 1 Lakh and the overall balance due is Rs. 1 Lakh, this means you have maxed out your credit card.

What is Credit Utilization Ratio?
Why you should never max out your credit card?
What to do about Maxed-Out Credit Cards?

What is Credit Utilization Ratio?

It is the ratio of your overdue balance to the total available limit. The credit utilization is seen across all your loan accounts and not just credit cards. This ratio plays a very important role in your credit profile. A low credit utilization ratio is considered good whereas a high ratio shows that you are a credit hungry person. It is advisable to maintain the credit utilization ratio below 30%. If you have no other loan accounts, only credit cards, then it is advised to never exhaust your credit limit.

Also Read: Tips for Lowering Your Credit Utilization Ratio

Why you should never max out your credit card?

A maxed-out credit card is no less than a nightmare as it has serious consequences- ranging from huge penalties and a ruined credit score. Here are some common situations you should be ready for if you have maxed out credit card.

  • You may get stuck in a debt cycle

When you have utilized the entire available limit, it means that you have a lot to pay back. Even if you have converted the transactions into EMIs, the amount will be quite high. And if you have other credit cards bills and loan EMIs to pay, it may get difficult to manage so many dues at once. With this, the chances of missed payments also increases which may lead to a cycle of debt.

  • You may have to pay the penalties

Ideally, the bank does not charge any late fee or interest if you pay off your credit card balances in full and on time. However, as we have mentioned above, maxing out your credit card increases your chances of missed payment in which case the bank will start charging interest. Also, there are penalties for going above your credit limit. This is known as an over-limit fee and usually varies from 2% to 3% of the over limit amount.

  • Your credit score will drop

With your credit cards maxed-out, the credit utilization ratio will shoot up which, in turn, will drop your credit score. A low credit score will make it difficult for you to get new loans or credit cards. Even if a lender agrees to grant you a loan, you may not be in a position to negotiate a lower rate of interest.

  • Your credit history will be marred

A maxed out credit card reflects poorly upon you and the lenders would not like this. So, when you wish to take another credit card in future, the bank may reject your application despite a good credit score and high income. You would be considered a risky customer by the lenders and hence you will face difficulty in getting new loans because of this blemish in your credit history.

  • Your credit card would no longer work in your favor

One of the top reasons why people get a credit card is to have access to credit when they need it. If you max out your credit card, that benefit would not be available to you. This is when a credit card starts to feel like a burden as you would not be using any benefit just paying the bills.

Suggested Read: How Credit Cards Affect Your Credit Score

What to do about Maxed-Out Credit Cards?

You are likely to utilize much of your credit limit in case you current income is not enough for a living standard that you want so you put it on your credit card. If you have already stuck in the situation, your credit score is likely to get hit first. The only way to solve this problem is to reduce your credit utilization ratio. There are two ways to do this-

Increase Your Credit Limit

When the credit limit available with you increases, the credit utilization ratio automatically reduces and hence the credit score improves. You can ask your bank for a limit increase on the same credit card or you can apply for a new card. However, in both the cases, the bank would not be very keen to offer you a new card or a limit increase. Since you have maxed out one card, the bank would consider you as a risky borrower.

Also, it is not advisable to apply for a new credit card with another bank when you already have a maxed out card. This is because the bank is more likely to reject your application and it may further worsen your credit situation.

Pay off the Balances

The second way to improve your credit score is to pay off the balances quickly. Pay off the balances in full if you can afford it. As you keep clearing the balances on your credit cards, your credit utilization ratio would also improve. Also, if you have paid off a bigger portion of your debt, the bank would also respond positively to your limit increase request. You can work towards increasing your income or generating more sources of income so that you can afford an early payment.

An important thing to note here is that any improvement on your credit will take at least 2 to 3 months to reflect. So, you will have to face the circumstances of a maxed out credit card for some time.

Also Read: Ways to Deal with Piled up Credit Card Debts

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