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Credit cards are one of the most easily accessible and user-friendly money tools out there. Read on to learn why they’re best approached with caution, though.
Despite what some well-known and especially loud voices in the personal finance space will tell you, credit cards aren’t evil. In fact, they’re one of the best financial tools out there for everyday people like you and me.
Credit cards are widely available, and you can even find them with no annual fee. In exchange for using one, you can earn rewards in the form of cash back and points for future purchases. A credit card is the easiest way to build credit, as when you make purchases using it and then pay your bill (on time and ideally, in full) every month, you’ll show creditors that you can be responsible with borrowed money. And credit cards come with robust safety features, such as fraud protection.
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Just because credit cards come with these useful features doesn’t mean it’s not possible to get into trouble with them. Overspending is a particular risk of credit card usage, because it can be easy to get carried away and forget that all you spend must be paid back. Here’s what you can expect if you overspend using your credit card.
You could max out the card
The possibility of this happening is dependent on your credit card limit and the kind of spending you do, but it’s certainly possible for a lower-limit card (which is what you might have if you’re new to credit cards). Maxing out a credit card is when you spend the entire allotted credit limit, leaving you with $0 in available credit and a big bill to pay.
If this happens, any additional transactions you try to make will be declined. If you’ve opted in for over-limit protection, you will be able to spend more, but you’ll be charged a fee for doing so. It’s not a good idea to max out your credit card, so keep your credit limit top of mind when using the card.
Your credit utilization ratio might end up too high
Charge too much on a credit card and your credit utilization ratio will increase. Your credit utilization ratio is the percentage of your available credit that you’re using at any given time. Let’s say you have a credit card limit of $10,000 on your credit card, but you’ve charged $4,000 worth of purchases on it. In this instance, you have a credit utilization ratio of 40%. However, it’s best to keep this number under 30% to avoid credit score damage.
Your credit score could take a hit
If you’ve overspent on your credit card and ended up with too high of a credit utilization ratio, your credit score could be at risk. Credit scores are made up of different factors that are also weighted differently to reflect their impact.
For your FICO® Score (the one used by 90% of lenders), credit utilization ratio makes up 30% of your score. It’s this important (second only to payment history, which is 35% of your score) because credit usage is reflective of your financial situation. If you’re so heavily dependent on your credit cards to maintain your lifestyle that you are routinely using more than 30% of your available credit, it signals to lenders that you might be in financial trouble now, or will be in the future.
You might have to pay interest on your balance
It stands to reason that overspending on a credit card means that you lack the money to pay off your balance before you’re charged interest on it. Credit card interest is bad news and having to pay interest on a huge balance can sink your finances fast. The average credit card interest rate is over 20%, and interest charges are compounded daily, so rolling over a balance month to month just means you’ll pay a lot more to get rid of your debt. It’s not a good situation to be in, and overspending on your credit card is best avoided for this reason, too.
Credit cards can be a great way to build credit, take advantage of fraud protection, and earn rewards on your spending. But they are best handled with care, so be mindful of how much you’re spending and do your best to use your credit card responsibly.
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