A lot of people are usually eager to get their first credit card. But like other lines of credit, it requires one to maintain low balances and pay off the entire amount each month. As a newbie in the area, though, how low should that balance be? Or if my credit limit is $300 how much should I spend each month without impacting my credit score?
Well, this will be our discussion today, whereby I’ll share with you everything you need to know about credit balance. In the article, we’ll cover all the questions on what it’s, why it’s important, when it’s acceptable, and how to maintain it.
But before we come to all that…
Credit Limit is Not Just Limited to Credit Cards
Indeed, it’s not. Of course, we mostly relate the term with revolving credit, such as credit cards. But you’ll also find limits on other types of loans as well, including personal loans and even shop now and pay later catalogs.
That said, we can define credit limit as the maximum amount you’ll have access to on your line of credit. For instance, our reference limit of $300 is what many people get when they get approved for a credit card for the first time. Then, you can grow your limit later on when you prove to be dependable and financially responsible.
The main way to prove this is by using your credit account and paying back the balance each month by the due date. However, whenever you use your credit account, perhaps for purchases or cash advances, you have to ensure the available credit/ balance is always within the standard range.
What’s the Available Credit/ Balance
Technically, Credit Limit and Available Credit are two different things, but sometimes we can use them interchangeably. Available credit is the number left after you subtract the amount of purchases from your credit limit. In other words, it’s the funds that will be available on your card for you to use during emergencies.
Similar to a checking account and debit/ prepaid card, though, your credit balance doesn’t decrease from just the amount of purchases. But also any interest or fees that may be involved in your transactions. So, you might want to be monitoring your monthly statement closely to track changes in these fees.
Why Does My Credit Balance Matter?
If I was to be straightforward, overusing your credit account can have negative consequences on your financial health. And the term overusing here is not only about going beyond your overall credit limit but also having a balance equal to it.
Technically, that’s what we call maxing out a credit card- using your credit account until or beyond the borrowing limit. That’s you spend your credit card until you have zero or an overdraft as your available credit.
Now, when that happens, the lenders will consider you a higher credit risk and might doubt your ability to repay the debt. So, they might rethink keeping the relationship then or in the future.
The professional term for the scenario is credit utilization rate, which refers to the amount of revolving credit you’re using divided by the total credit limit. It’s usually expressed as a percentage, which is crucial to both the lenders and credit bureaus. Why?
Well, for one, we’ve said maxing out your credit limit could have the lenders doubting your financial management. Secondly, credit scoring models like FICO and VantageScore do use your credit utilization rate when calculating the credit score.
If you can remember our previous talk on how long your credit score will improve with credit cards, we mentioned credit utilization accounts for 30%. Indeed, that’s relatively significant and could even hinder the chances of improving your score fast when off the track.
But then, if my credit limit is $300, how much should I spend to increase my spend Limit and credit score fast?
When’s My Avaivalable Credit Balance Considered Good?
Usually, many believe your total credit utilization should be no more than 30% if you want to better your credit score and amount limit. According to Experian, one of the major credit bureaus, your credit score could take a big blow when your utilization ratio is beyond that.
The company further provides that most people with exceptional credit scores usually have a credit utilization under 10%. Other financial experts, including John Ulzheimer (formerly with FICO and Equifax), confirmed the statement, adding that you should aim for a single-digit utilization rate.
In other words, that means in your credit limit of $300, you should maintain an available credit of at least $210. So, you’ll need to have an outstanding balance of at most $90 by the end of your monthly billing cycle. Yeah, the date of the billing cycle is important as it’s mostly around the time lenders report your outstanding balance to the credit bureaus.
More on that, this balance is what will appear on your monthly credit card statement. So, you could be paying your credit card/s off in full before the due date, yet still, your report shows a utilization ratio of over 30%. Also, you could be using all the amount on your credit limit, but still, your report shows a 1% utilization ratio. How?
Well, this now brings us to the final part of our topic, whereby we’re going to look at the various ways to reduce your credit utilization rate. Or otherwise…
How to Maintain a High Available Credit Balance?
At this point, we can conclude that the credit utilization rate is inversely proportional to your credit balance. If math was never your strength in junior high, that simply means your available credit balance increases with a decrease in the utilization ratio.
Therefore, to maintain a high available credit balance that is acceptable to both the lenders and credit bureaus, you need a strategy to manage your credit utilization rate. There are about five key methods to do that. They include:
Technically, revolving credits like credit cards are usually to take care of emergencies before your paycheck processes. They’re also the easiest way to build and rebuild your credit score. Hence, the reason we have companies like Discover It with Guaranteed Approval credit cards for bad credit.
On the contrary, you have to maintain a low credit utilization rate each month you use the card. So, you might want to spend on only the essentials while avoiding impulse purchasing, which will just lead to unnecessary overspending.
Remember, most credit cards also have fluctuating interest, not fixed rates as installment credits. And as was mentioned earlier, the issuer will also deduct the interest and transaction fees from the available balance of your credit limit.
Paying Your Credit Card Early:
Yes, indeed, paying your outstanding credit on time can also help improve your utilization rate and available balance. However, the trick isn’t just about paying the full amount you owe, as many tend to think. You also have to time your payments in such a way that they’re before the lender reports to the credit bureaus.
Typically, at the end of the billing cycle (also called closing date), lenders collect your monthly card usage, including the interest charge and the minimum payment. Then, compile your billing statement, which will have the total outstanding balance that you need to pay. The due date of most cards is usually 21 – 25 days (also called the grace period), which means you can pay within this time without penalty fees.
However, lenders happen to report your outstanding balance to the major credit bureaus at the end of a billing cycle as well. So, your report will still show a balance even after you pay the full amount during the grace period. If you paid off your balance before the closing date, what remains is what will appear on your statement and credit report.
Therefore, making your outstanding payments early (before the closing date) can help reduce the total balance that the lender reports to the credit bureaus. Thus, keeping your credit utilization rate low and the available credit amount high.
Increasing Your Total Credit Limit
As was mentioned, the people with the highest credit score tend to record a low utilization ratio of up to 1%. One of the ways they manage this is by having a high credit limit, which can range up to $100,000. And the higher the limit is, the more the amount of credit available for you to spend.
Meanwhile, lenders usually increase your credit limit when they notice you’re a responsible cardholder, have a good score., and have adequate income. Some tend to give the credit increase automatically, but others require you to submit a request.
Leaving Your Old Accounts Open
In this method, the trick is to leave the credit cards you no longer use open instead of canceling them. Of course, you might still have to pay their annual fees even when they have zero balances, but they can help avoid hurting your utilization rate and credit score.
That’s when you have multiple cards under your credit account, your credit limit is also higher. If you close one of these cards when you already had carried a balance, the result will be a decrease in your total available balance. This will then cause an increase in your credit utilization rate, which then pulls your credit score down if it’s beyond the recommended 30%.
Opening New Credit Accounts
If approved, a new credit account can also improve your overall utilization ratio and credit score. As I’ve just said in step three, you’re sure to have a higher limit with multiple lines of credit. And when the limit is high, you’re likely to spend less of your available credit.
The amount of funds you spend on your credit account is very important if you want a good report from your lender and credit bureau. For the best results, you have to ensure the outstanding balance at the end of your bill cycle is at the lowest.
As a first-timer, though, the lenders usually start you with a low limit that you’ll increase with time when you prove to be dependable.
If it’s a limit of $300, the recommended 30% credit utilization rate provides that you should have an outstanding balance of at most $90 by the statement closing date. But as I’ve shared in the article, this doesn’t mean you can’t use the other $210.
In the event of an emergency, you could use the whole available balance of $300, but you make sure you pay the balance early. That way, the lender will have low to no balance on the closing date to report to the national credit bureau. Thus, there won’t be any negative impact on your credit report.