How Much Credit is Too Much?
In a world that seems to be run on credit, it is difficult to know just how much credit is too much. After all, we are constantly offered opportunities for even more credit. On the television, in our mailboxes, and on our computers, we constantly receive offers to apply for credit. Out monthly bank statements often include offers for loans. Everywhere we turn, the message is clear: credit is king.
We are also constantly told that more is better; isn’t that why everything these days is super-sized? How can you know how much credit is actually too much credit? Luckily, there are a few things that you can look at as a consumer in order to answer this question.
If you ask a financial or credit expert, they will probably tell you that no more than 15-20% of your monthly household income should be committed to paying off credit debt. This includes credit card and other loan payments, with the exception of your rent or mortgage. If you factor in the rent or mortgage, then the rule of thumb is that no more than 40% of your monthly income should go to paying the total of all debts. Known to experts as your credit analysis ratio, this percentage is a figure representing what you owe in comparison to what you actually earn. This ratio is considered to be a clear indicator of your overall financial well-being.
When you add a new line of credit to your life, you are not actually adding more income, even though it may feel that way. Credit is not the same thing as money. What credit does is allow you to defer payment. It simply changes the way that you pay for things. Under the expected circumstances, you then pay off any major loans, such as a car or mortgage loans, according to the payment schedule worked out within an allotted period of time. For credit cards and any higher interest credit, you should try to pay the “loan” off much sooner. This means that instead of simply paying the minimum payment, which will only prolong the debt and actually add to the total loan, you pay as much as possible each month. The best-case scenario is that you pay any credit card balances off in full monthly, but if you aren’t able to do that you should pay as much as possible.
The simple truth is that if you ever have trouble making the amortized or agreed-upon payment on a major loan, you are probably carrying too much debt. Likewise, if you ever find yourself making only the minimum payment on your credit cards each month then you have almost certainly accumulated more debt than you can realistically handle. If you let yourself fall into the trap of continually paying only the minimum amount on all of your debts, you will find that you are not simply breaking even, but actually adding to your total debt each month because of the accumulating interest.
The terms for any credit card or loan will include certain fees and expenses in addition to simply repaying the loan amount. The fact is that you actually end up paying back far more than you originally borrowed. The only exception to this is if you have a credit card with no annual fee and pay off the balance in full each month before the end of the grace period.
The sensible use of any type of credit requires responsible payment practices. It is important to make certain that you are not carrying more credit than you can afford, and that your current debt is being paid down instead of added to. Think carefully before opening any new line of credit, whether it is a bank credit card, a store credit card, or a new loan. Never apply for any type of new credit unless you are certain that you have control of your current expenses and can sensibly manage the additional amount.