In almost every situation, maxing out your credit card is a bad idea. While it might be tempting to take advantage of your available credit to live a lifestyle you otherwise could not afford, the financial repercussions are serious. Maxing out your card damages your credit score, limits your financial options, and can propel you into a perpetual cycle of debt.
As with just about anything though, it depends on the context. There are some situations in which maxing out your credit card is understandable or even preferable to the alternatives. To understand when maxing out your credit card is okay, however, you must first understand the potential consequences.
Why maxing out a credit card is dangerous
It can be harder than you’d think to grasp the dangers of maxing out your credit card. While a maxed-out card comes with plenty of risks, some might not be immediately apparent. Here are four of the most important consequences to keep in mind.
- It damages your credit score
Many different factors go into calculating your credit score. As you probably know, factors such as your payment history, the length of your credit history, and the presence of negative judgments such as bankruptcies all affect your score. However, did you know that the amount of debt you carry on your credit cards also plays a role in determining your credit score?
Your “credit utilization ratio” measures how much of your available credit you’re currently using. Your ratio factors into both your overall utilization and your utilization on each account. If you have two cards with a total credit limit of $5,000, and you’re using $4,900 of that limit, that’s bad. If you have a zero balance on one card and a high balance on the other, that’s bad as well.
Thirty percent is the golden number for credit utilization. Creditors like to see that you do use your credit cards, but if you’re using more than 30 percent of your total credit, it’ll likely hurt your score.
By maxing out your credit card, you put at least one of your accounts well over that 30 percent threshold and likely damage your overall credit utilization ratio as well. While your credit utilization won’t make or break your credit score on its own, it can have a big impact if your score isn’t already airtight. FICO, the creator of the world’s most popular credit scoring calculation, states that maxing out a credit card can cause your score to drop anywhere from 10 to 45 points overall.
Even 10 points can be the difference between gaining approval for a loan and facing denial, so it pays off to make sure your credit score is the best it can be.
- It will cost you a lot of money in the end
If you’re like most people, the most expensive thing about spending with credit cards isn’t paying off what you spent; it’s paying down the interest. Interest can compound monthly or even daily, and unless you’re aggressive about paying down your balances, interest can get away from you quick.
That’s especially true if you’re considering maxing out your credit card. The amount of interest that compounds on your account is a function of the size of your balance. In other words, if you owe more, you’ll pay more interest. If you’re maxing out your credit card, you’re giving the credit card company the ability to charge you as much interest as it possibly can on your account. As you might imagine, this isn’t good for your finances.
With every interest charge calculated, your chances of paying your credit card off anytime soon get more and more remote. Your balance grows, and your next interest payment calculates based on the new higher balance, making it harder and harder to pay your bills.
If you’re only able to make your minimum payment (which has probably gone up since you maxed out your card), things deteriorate. Say you have a card with a $5,000 balance and a 20% APR. With a minimum payment requirement of 3%, it’ll take you over 18 years to pay that card off if you’re just making minimum payments, costing you far more than the original $5,000 purchase in the end.
In simple terms, financing a big purchase by maxing out your credit card is the most expensive way to shop. You’re sure to spend a whole lot more money than you intended and struggle with debt payments for months (or even years) just to get your financial life back on track.
- It makes you more financially unstable
So far, we’ve been a bit negative regarding credit cards, but they definitely have their benefits. Credit cards allow you to borrow against the future, taking out “loans” from credit card companies that help you to stretch your paycheck and exert a little bit more control over your financial life. Credit cards give you a reserve of capital that’s easy to access in case of emergency. Using a credit card responsibly, therefore, can help to make your finances more stable and more predictable.
If you max out your card, all of that goes out the window. You no longer have access to any kind of useful amount of credit that you can rely on in case of emergency (or even if you need a little help to make ends meet). Instead, you have a very expensive debt that needs attending each month just to keep it from spiraling out of control. In other words, you’ve turned a useful tool into a liability.
Moderation is crucial if you’re trying to get the most out of your credit cards. Maxing out your card makes moderation impossible.
- You could face a penalty
While creditors want you to use your cards, maxing out a credit card is a red flag for them. It’s a sign that you’re financially desperate and have become a risky borrower. To minimize their risk, creditors might penalize you for maxing out your account.
In some cases, creditors might hit you with a penalty APR. This is especially likely if your maxed out card leads to other issues, such as late payments. Penalty APRs are the highest interest rates that creditors can possible charge. You could see your interest rate jump to as high as 29.99% overnight. This increase will make it even harder to make any significant progress toward paying down your debts.
In other cases, a creditor might simply close your account. Arguably, this is worse than facing a penalty APR because it eliminates your ability to use your card, converting it into nothing but debt. All of a sudden, your card becomes very expensive dead weight. While it’s possible to get your card reinstated, it’s still no fun to deal with it closing in the first place.
When is it okay to max out your credit card?
So far, we’ve tried to make it as clear as possible that it’s almost never okay to max out your credit card. In most cases, maxing out your card is setting yourself up for financial disaster. That said; there are some situations where it’s understandable to spend up to your credit limit.
You’re dealing with a serious emergency
Most people carry a credit card designated for emergency use only. Opening up an emergency credit card is a smart move for anyone with a limited income. Emergencies are expensive, strike without warning, and usually require a swift response. If you don’t have enough money in your checking or savings account to finance the emergency, turning to your credit card is often your next best move, even if you have to max it out.
Imagine you’re taking a road trip and in the middle of nowhere, far from home and far from your destination. Your car breaks down unexpectedly and you’re stuck on the side of the road. You call for a tow truck and end up at a local repair shop. They can fix your car, but it’s going to cost about $3,000 more than you have on hand. Turning to your credit card makes sense here, if only because you don’t have many other options if you’re trying to get back on the road anytime soon.
Medical emergencies are also acceptable when it comes to maxing out your credit card. From ambulance rides to emergency room visits, medical bills can pile up fast, but trust us: your life, health, and well-being are far more important than keeping your credit score pristine, so if you have to max out your credit card to get the treatment you need, don’t feel guilty.
You can’t make ends meet without it
Imagine that you lose your job tomorrow. All of a sudden, your life is in turmoil. Even if you qualify for unemployment, your income has taken a hit. Just paying your bills will become a struggle, and getting to the end of the month might seem impossible.
In this type of circumstance, it might be acceptable to spend more on your credit card than you usually would. You’ll have to make this call on your own, however. Obviously, financing your day-to-day life on a credit card is not a sustainable practice because you’ll end up paying more than you have to for everything you buy. If you think you’ll be able to land a new job soon, it might be worth holding out for that next paycheck instead of maxing out your card.
That said; in dire financial circumstances, it can pay off to keep some cash reserves in your savings and spend on your credit card instead. There are certain things you might need cash for, such as putting down a security deposit on a new apartment. If you spend all your cash before you turn to credit, you might inadvertently limit your options. Cash simply provides a level of financial security that credit cannot.
Of course, it’s vital to make sure that you’re maxing your credit card out for the right reasons. Sometimes, we get tempted to swipe our credit cards instead of paying cash simply because we want to avoid the psychological distress of watching that money come out of our bank accounts. This desire for avoidance will only be stronger when you’re struggling financially, so make sure you think hard about your situation and your options before you opt to swipe that credit card.
You’re transferring your balance to a 0% interest card
Balance transfers can be enormously helpful if you’re struggling with debt. They’re essentially a form of debt consolidation in which you transfer the balances of multiple credit cards over to a single card. The new card should have a low promotional interest rate, with the best balance transfer cards actually charging no interest at all for a significant period.
Balance transfer cards allow you to pay off your debts more aggressively without having to worry about interest compounding and undermining your efforts. Ideally, you’ll be able to consolidate all your credit cards into a single monthly payment and eliminate the entire balance of the card before the promotional interest rate ends, saving a huge amount of money in the end.
If you have a significant amount of credit card debt, then you might end up maxing out your new card when you transfer your balances over to it. This might not look great to the credit scoring agencies, as all they’ll see is you opening a new account and immediately maxing it out. However, if the balance transfer contributes to your long-term financial health, then it’s well worth it.
In general, however, maxing out your credit card is a bad idea. Even if you think you have a good reason to do it, take the time to examine the pros and cons and ask yourself if it’s really worth it.
