26-April-2016 written by : FSI-Team
The very mention of a credit card makes most of us feel good, as there is something about possessing that little rectangular piece of plastic that can be the key to your aspirations. Of course, while it is exciting to make purchases on a card it is equally important to stay credit healthy by ensuring that you use your card judiciously and do not borrow more than you can repay. This is because ultimately a credit card is nothing but a type of unsecured loan and needs to be paid off once the bill comes in, much as you would pay a loan EMI.
What then should you be aware of before you embark on your voyage of credit card usage? Well, for starters, know how your credit card works – get information with regards to the fees and charges, rewards and benefits and related information before you sign along the dotted line. In addition to these important aspects, know that your credit limit is something that is equally critical and needs to be monitored if you are to remain sound credit health-wise.
With every card comes a credit limit, for instance a credit limit of Rs. 3,00,000 will allow you to shop on your card for up to the said amount when you need to. Similarly, each of your cards (if you own or use multiple cards) carries a pre-determined credit limit and this can have an impact on your credit health. Let us see how.
Very simply, someone who utilises high or excessive amounts of credit month on month is likely to be someone who is not very solvent, or could be going through financial difficulties. Let us say you apply for a fresh line of credit, i.e. for instance a home loan. When a lender reviews your credit card application they pull a copy of your CIBIL report, which also contains details about your credit card usage. If your usage is high, it is likely to trigger off a red flag to the prospective lender, who may then choose to deny you any further credit. So let us see how your credit card usage is linked to your credit report.
As mentioned, each card has a credit limit, and a credit utilisation ratio tells you how much of the credit available to you is being utilised across all cards (or even one). The ideal ratio to adhere to is 30 percent of the total limit as lenders tend to consider this to be stable usage, wherein it is unlikely that a cardholder is leaning towards debt. On the other hand, consistently maxing or reaching close to your credit utilisation limit signifies to a lender that you may be in more than just a spot of trouble financially. A high credit utilisation ratio is one of the factors of CIBIL score calculation process.
Let us now understand the correlation between the ratio and the score. Among the factors that are used to calculate an individual’s CIBIL score, this ratio plays a significant role. A score can remain high (or increase) over time depending on how you service existing credit, and on the other hand can also dip if the way you handle credit is not optimal.
A high score is your gateway to financial fitness as you are more likely to be offered loans at better (that is lower) rates of interest; it can also sometimes be the reason why an application is declined in the first place.
While there is no magic number per se, the thumb rule to establish what your card limit should be is rather simple. A very low limit will mean that having a card may not be much use – for instance, when you plan to buy a new refrigerator and are unable to make the purchase on your card because of the limit constraint; it defeats the purpose of even maintaining a card. On the other hand a very high limit can also work against you, because it’s human nature to overextend themselves just because the option is open to them. Hence you may just find yourself in a position wherein you spend more than you should (or can repay, once the card bill comes in), only because you had the limit available to you.
If as a consequence you wind up spending more than you should, and roll over payment or delay or skip them altogether, you are at risk of severely damaging your credit score. And do keep in mind that once a score drops, there are no ways to improve your credit score fast.
Remember that a high limit card may look flashy and up your social quotient, but at the end of the day it is your wallet and your credit health. In order to remain credit healthy therefore, opt for a credit limit that is both realistic and reasonable and does not tempt you to spend unnecessarily. Even by simply monitoring your card usage and being diligent with payment, you will do your credit health a world of good.