The borrower’s dilemma: If you are overspending on credit cards, should you decrease your credit limit or find an alternative? The fact is, if you are overspending on credit cards to the point where you should decrease your card limit, you are likely in a worse situation than card limit considerations will solve.
If it’s this bad …
You have a choice: Either you feel out of control and need to see a debt counselor, or you feel like you can handle overspending yourself. This article is for the do-it-yourselfer, because there are plenty of things you can do, but decreasing your card limit isn’t the best option.
Credit utilization rate
If you are overspending on credit cards, you should not decrease your card limit, because it will have a negative effect on your credit score. Thirty percent of your credit score consists of how much you owe, also known as your debt utilization rate. This is the ratio of how much debt you have outstanding divided by the total credit lines you have.
The smaller this ratio is, the better. So, if you decrease your card limit, you are making the denominator of this ratio smaller, and thus the ratio becomes larger.
You need to be extremely careful about credit utilization, particularly if you plan to apply for new credit in the future. You want that utilization number to be as low as possible. A new lender wants to see that you are using a lot less credit than you have available before granting you additional credit.
If that utilization number is high, you will appear to them as being a greater risk, and they’ll be less likely to grant that credit. If that credit is for a car or house, all the more reason to be on top of things.
There’s another problem with decreasing your card limit. You will make it that much easier to max out your credit card, and you want to avoid this.
Although many cards have eliminated over-the-limit fees, maxing out your credit card may in fact mean going over your credit limit, which will trigger fees. You have to opt-in to have the fee charged, which sounds silly, but you are really opting-in for permission to exceed the limit so the issuer can charge you a fee.
If you have opted-out of going over your limit, then maxing out your credit card literally means getting cut off. If you are facing an emergency and you need to pay for something like medical care, you will regret maxing out your credit card.
Learn good habits
Now, you need to establish good credit and budget habits. Here are a few quick tips.
- Pay your credit card on time, every time. 35% of your credit score is based on payment history. Do whatever it takes to remind yourself of your card’s payment due date. I like to set automated payments from my bank account. Just make sure that your bank account has enough money in it or that you have overdraft protection.
- Don’t apply for new credit. Get your current situation under control first.
- Make a budget. Make sure it reflects a realistic level of spending. That’s why you’re doing this in the first place.
- Do a weekly check-up. Tally up your expenses each week. Make sure you are sticking to the budget. If you are going over your limits, you must discipline yourself and make cuts.
- Do a monthly check-up. Did you hit your budget? Congratulations. Did you overspend again? Try harder.
Overspending image via Shutterstock