For instance, if your credit card limit is Rs 3 lakh and your outstanding balance is Rs 3 lakh, your credit cardis maxed out.Maintaining a lower credit balance not only enhances yourcredit score but also reduces the risk for lenders when considering your loan applications.
How is credit utilization ratio calculated and why is it important?
The credit utilization ratio is calculated as the overdue balance on your credit card divided by the total available limit.
This ratio is a pivotal factor in your credit profile. A low credit utilization ratio is favorable, while a high ratio indicates difficulty in managing spending. It’s recommended to keep the credit utilization ratio below 30%, especially if you rely solely on credit cards. Avoiding maxing out your credit limit is advised for a healthier financial standing.
A lower credit utilization ratio positively influences your credit score, ranking as the second most crucial factor after your payment history.
Reasons to avoid maxing out your credit card
Maxing out your credit card can lead to serious consequences, including hefty penalties and a damaged credit score. Here are common situations you should anticipate if you find yourself with a maxed-out credit card:
- Penalties: Maxing out your credit card raises the likelihood of missed payments, leading to interest charges. Additionally, exceeding your credit limit incurs penalties known as over-limit fees, typically ranging from 2% to 3% of the over-limit amount.
- Debt cycle trap: Exhausting your credit limit means a substantial amount to repay. Even if you convert transactions into EMIs, the total amount can be challenging to manage, especially if you have other credit card bills and loan EMIs. This situation increases the risk of missed payments, initiating a debt cycle.
- Impact on credit history: Maxing out a credit card reflects negatively on your credit history. When applying for another credit card in the future, even with a good credit score and high income, the bank may reject your application due to your maxed-out history.
- Credit score drop: A maxed-out credit card increases the credit utilization ratio, resulting in a lower credit score. A diminished credit score makes it harder to secure new loans or credit cards, and even if approved, negotiating favorable interest rates becomes challenging.
- Lost card benefits: A maxed-out credit card loses its primary purpose – providing access to credit when needed. Instead, it becomes a burden as you find yourself paying bills without enjoying any benefits.
What to do if you maxed-out your credit card?
If you find yourself close to maxing out your credit card, your credit score is likely at risk. To mitigate this, focus on reducing your credit utilization ratio through the following methods:
- Increase your credit limit: Request a credit limit increase from your bank, or consider applying for a new credit card. However, be cautious, as having a maxed-out card makes you appear as a risky borrower, potentially hindering approval.
- Pay off balances quickly: Clear your credit card balances as swiftly as possible, ideally in full. This not only improves your credit utilization ratio but also demonstrates responsible financial behavior. Increased debt repayment may also prompt a positive response to a limit increase request.
Remember, improvements in your credit score take time to reflect, typically requiring 2 to 3 months. While facing the consequences of a maxed-out credit card, actively work towards restoring financial stability.