How much should you use a credit card?
Credit cards can be a very useful asset to your personal finance. Careful and considerate spending on a credit card can help you improve your credit score, which will work to your advantage if you want to apply for future credit. If the credit card has a reward program, your spending can also help you accrue points to be used for discounts, rewards or even cash back.
Not everyone will use a credit card consistently and/or wisely. Here, we look at the effects of overspending as well as what do to if you longer use one of your credit cards. Firstly, let’s look at what happens when you overuse your card and end up hitting or going over the limit of your credit.
Immediate impact – the point of transaction
You are at the counter about to purchase something that will potentially take you over the credit cards limit. Here are the most likely outcomes:
- The transaction goes through with a fee charged. You may have chosen to allow over the limit transactions + fees at some point during the application, or since you have been using the credit card. Your credit card provider will outline the fee in the terms and condition. To remove the ability for a transaction to go through if you go over the limit of your credit card, you will need to contact your credit card provider.
- The transaction goes through without a fee. Some card providers may not charge a fee for going over your limit.
- The transaction is declined. Your credit limit may be a hard stop on your usage on the card. If this is the case, you will be unable to make the purchase with your credit card.
The credit card provider may take action in a couple of ways if you go over the credit limit. Firstly, your next monthly payment may increase. In addition to the minimum monthly amount, you may have to repay the amount you overspent. Remember that not meeting your monthly payments will result in further charges.
The credit card provider could also take the decision to reduce your credit limit if you are often overspending on your card.
Long-Term impact – Credit
Overspending on your credit card can have an adverse effect on your credit score as your ‘utilization rate’ plays a large factor in determining your creditworthiness. Lenders pay special attention to this rate as they see consumers who constantly charge all the money they can, or go over the limit on their credit card, as less likely to be able to repay a loan.
Definition: Utilization Rate – The amount of available credit that you have used.
Tip: It is a good idea to keep your utilization rate at around 20-30% of your credit limit.
I have stopped using a card
Consumers often take out credit cards to utilize specific offers from the credit provider, such as a 12-month interest-free balance transfer. Once the offer period has expired and the amount owed is completely repaid, the cards are used less, if at all. Is it then wise to close your credit card account or keep it open?
It is in your interest to keep your credit card account open even if you do not use the card any longer. For the reason we look again at utilization rate. If you keep a credit card open but do not use it, the credit limit is still included in your utilization rate calculations by credit bureaus. This means that you can safely spend on your other credit cards without having to worry as much about going over the 30% utilization rate.
Keeping credit card accounts open can have a negative effect on your credit score when you have too many at once. It is a good idea to have a maximum of 3 or 4 credit cards. If you have more, the long-term positive effect of closing some of the accounts will likely outweigh the short-term negative effect. Credit bureaus look at the average age of your credit when determining the score, with older credit accounts having a good impact on your overall score (if all other factors are equal). This means that if you are deciding which account to close it is best to close the newer credit card and keep older ones open.