This monthly series by personal finance specialist Amanda Reaume focuses on how to improve something that many people overlook: your credit score. These posts will give you tips and tricks to improve your chances of getting approved for better rates when you apply for credit – leading to better student loans, car loans and even mortgages.
No one sets out to max out their credit cards. Sometimes, people get into this difficult situation because of an unexpected emergency such as losing their job or experiencing an illness. Many people have to rely heavily on credit cards during that time to cover their everyday expenses. For others, they may have difficulty controlling their spending and their debt gets out of control.
No matter the reason why your cards are maxed out, using up the last of your credit is often an important wake up call to address your financial situation and get control of your spending. While you might be tempted to just focus on repaying your debt, it's important to consider your credit score during this period. Having a low score can greatly impact your financial future and your ability to get approved for mortgages and other loans and get a good interest rate. In addition, many employers and landlords require a credit check when deciding whether to hire or rent to you.
If you've maxed out your credit cards, here are a few suggestions on what to do to ensure your credit score stays high:
Ask for More Credit
This might seem counterintuitive, but increasing your available credit can help boost your credit score significantly. That's because about 35% of your score is calculated based on your credit utilization – the percentage of your available credit that you're using at any particular time.
If you've maxed out your cards, that means that you are using 100% of your credit. Experts say that you get the best score if your utilization is just 20% to 30% of your total available credit. By increasing your credit limit, you will be using a smaller percentage of what’s available. However, it can be a challenge to convince credit card companies to increase your limit, since maxing out your credit cards can make you a credit risk. Even if they do extend you additional credit, they likely will not offer you enough extra credit to ensure that your credit utilization goes down to 20% or 30%.
Still, that additional amount of credit will help boost your score, meaning you can pay off less of your credit balance in order to get back to the 20% to 30% optimal utilization. Just be careful: if you aren't able to control your spending and believe that you could end up spending that additional credit, then you're better off not getting it at all.
Make a Plan to Pay Off Your Debt
The best thing you can do when you max out your credit cards is to start paying off your debt. I have covered this topic extensively in my 12-part series “12 Months to Being Debt Free.” Here I list a number of ways to plan for paying off your debt.
The fastest way to become debt free is to pay down the card with the highest interest rate first, the second-highest rate second and so on. But if you're concerned about your credit over the short term, then it might actually make more sense to simply focus on the card with the highest interest rate and pay it down until it gets to the 20% to 30% optional credit utilization ratio. Then you can repeat the process with your other cards.
By doing this, you ensure that you get out of debt as quickly as possible while boosting your credit score at the same time. Once all your cards are within the 20% to 30% ratio, then you can start paying them off in full.
Save for an Emergency Fund
It's important to figure out why you got into so much credit card debt in the first place and find ways to avoid doing so again. For most people, it comes down to a lack of a financial buffer. When emergencies happen, they rely on their credit card – an extremely expensive way to tackle urgent expenses.
You're far better off putting money into an emergency fund and using that when you encounter financial setbacks or difficulties. Typically, experts suggest that you save between three and six months’ worth of your salary in an emergency fund in case something happens. By doing this, you ensure that you don't land in the same situation again.
The Bottom Line
Maxing out your credit cards can be incredibly stressful, and the added stress around how it impacts your credit score doesn’t help. While there are a lot of ways to improve your credit score, these tips are specific to tackling the problems that maxing out your card will generate. By taking these steps, you ensure that your score will bounce back in the future.
This is the 3rd edition of Amanda Reaume’s monthly “How to Build Your Credit Score” series.