Using a credit card can be very helpful for boosting your credit score and for helping with cash flow. It can also offer you more protection for online payments.
Your bank will offer you a certain amount of credit based on your income and your credit history- but should you use all of this credit? Learn how much credit card debt is too much.
It can be tempting to max out your credit card, but it is important to remember that available credit is not the same as available money.
It will build interest and you could find yourself struggling to pay off your debts.
We have put together this useful guide to help you figure out the best way to use your credit card. Keep reading to find out more.
What Are The Different Types Of Debt?
Personal debt can be split into three different types – good debt, bad debt and toxic debt.
Good debt is when you take out a loan to pay for something that will increase in value or improve your financial situation. For example, taking out a mortgage to buy a house.
This is a sensible investment and houses often increase in value over time.
By paying your mortgage you are investing in your future rather than paying rent which is considered ‘dead money’. Taking out a loan to start up a low risk business is also good debt.
Bad debt is when you use a loan to buy things that will lose value or buy frivolous things.
The loan might have variable interest rates or a high interest rate. Taking out a loan to pay for a holiday or to go shopping is an example of bad debt.
Toxic debt is when you borrow money urgently to buy something even though the interest rate is very bad.
In these situations, you might find that you end up paying much more than the original value of the item due to the inflated interest rates.
People often get caught up taking out more toxic debt to escape from previous toxic debt, which can ultimately end in bankruptcy.
How Much Credit Card Debt Is Too Much?
So how much credit card debt is too much? It depends on your individual financial situation, but there is some general advice that you can follow to keep yourself from building up too much credit card debt.
Just because your bank is willing to offer you a certain amount of credit, does not mean that you should use it all.
You need to make sure that you can always afford the minimum payments.
The more you spend, the more the minimum payments will increase, and this will include interest.
If you let the minimum payments get too high then could end not being able to pay them and never being able to pay off the credit card due to the interest building on top of the original amount.
If you miss your minimum payments then this could go on your credit record and lead to you getting a bad credit score.
If you are not very good at remembering to make the payments, you should consider setting them up as a standing order so you know that the minimum is being paid.
If you have some spare money, you can pay back more than the minimum amount to keep your debts low. If you only pay your minimum payments then you will find it difficult to pay off the debt.
If you’re not sure how much debt is too much debt, you should compare the amount of debt you have to your annual income.
If your debts are 36% to 42% of your annual income then this is considered low risk and affordable. It should be relatively easy to come up with a manageable payment plan.
If your debts are between 42% and 50% of your annual income then this is considered to be too much and could be very difficult to pay off.
You might have to make a lot of sacrifices in order to become financially stable again.
You might also need to seek financial advice to see if you can consolidate your debts, transfer them, or to come up with a payment plan.
If your debts are more than 50% of your annual income then this is incredibly high risk and it is unlikely that you will be able to pay them off. You might have to consider bankruptcy as an option in order to start again.
This is a general rule and does not always apply. It depends on what other outgoings you have and how far you have to stretch your annual income.
If you have dependents then debts that equal 36% of your annual income could be too much, as you will have other financial responsibilities.
Maxed Out Cards
If you max out one credit card then you should focus on getting it paid off before you start building up more debt on another card.
You should try not to max out a credit card, and you should never max out more than one card at a time.
If you have a maxed out credit card this can damage your credit score. It could make it more difficult for you to get approved for things like a phone contract, a television contract, a personal finance loan to purchase a car, or even a rental property.
What Is The Best Way To Use A Credit Card?
If you want to use a credit card to improve your credit score, you should choose one thing to pay for with your card.
It could be your fuel or your grocery shopping – something you know you can afford that you buy on a regular basis. Pay the credit card off in full every month or two.
Having available credit can make you feel like you have lots of available money to spend, but you should be careful not to build up too much credit card debt.