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Is it possible to have too much credit available?
After all, if credit is made available, people will be tempted to take advantage of it – and possibly take out too much debt.
The Federal Reserve estimates that the total U.S. consumer debt (which includes credit card debt and non-credit-card debt but not mortgage debt) reached $3.7 trillion as of August, 2016. And that amount is rising rapidly .
The average American with a credit file has $16,635 in debt, excluding mortgages. In other words, a typical American will have over $16,000 in debt for a car, consumer goods and education. Or over $33,000 in debt for a typical couple. Before taking into account home loans.
That sure sounds like too much debt to me. But how much is easy credit to blame?
How Do We Accumulate So Much Debt?
It is easy to point out the rising cost of college as the reason for all this debt.
But the cost of college alone is not the problem.
On average, today’s consumer has thirteen credit obligations on record at a credit bureau. These include credit cards (such as department store charge cards, gas cards, and bank cards) and installment loans (auto loans, mortgage loans, student loans, etc.).
Of these thirteen credit obligations, nine are likely to be credit cards and four are likely to be installment loans.
That number of trade lines indicates that Americans are becoming very comfortable taking advantage of credit to buy just about anything.
How Much Credit is Too Much?
So how much credit it too much? The answer to that question will vary according to an individual consumers financial picture.
The best benchmark for this answer is your debt -to-income ratio. Your debt-to-income ratio measures how much debt you carry, compared to how much money (after taxes) you have coming in.
Credit companies allow about 25% of your income in debt. Of course, the best number is zero. But at the very least, you want to keep your debt, excluding mortgage loans -to 15% – 20% or less.
Keep in mind that the ratio for revolving and credit card accounts takes into consideration the full credit limit, not just how much you currently owe. Moreover, the amount owed on the credit accounts should not exceed 50% of their limit.
Before taking on significant amounts of credit, you should have in place an emergency fund in order to be able to keep making payments on time for your credit accounts. You will find this fund handy for minimizing the negative effects of lifeís little surprises.
For example, the stove that breaks down, the car that needs tires or other such unexpected need. They happen all of the time, so why not plan for them. This will help your credit situation because you will most likely be better able to pay your balances on time.
If after careful calculation you find yourself with significantly higher percentages of debt than the above allowances, then you may have too much credit.
However, going about the reduction of that excessive credit must be done carefully.
Consolidating credit and reducing credit debt can actually hurt your credit score. Creditors like to see a good mix of credit instruments and certain credit instruments can actually penalize you for early pay-offs.
Where to Start When Reducing Debt
Since two-thirds of an average consumers debt is with credit cards, they should be the first thing you look at when trying to reduce your debt-to-income ratio.
Credit agencies warn that the more cards you have, the bigger risk you carry for racking up debt and damaging your credit.
Ideally, you should be financially able to pay off credit card debt at the end of each month. That will ensure you do not incur extra fees or penalties that could eat up a minimum payment. In reality, however, about 55% of credit card holders keep a balance on their credit card.
If credit card debt is dictating your finances, you need to make some changes so that you are in control of it and not visa-versa.
You should be just as discriminating about the credit cards you close as the ones you open.
Before you alert your creditor that you want to close your account, make sure it is not going to affect your credit score in a negative way. For example, do not close a card that has a balance. When you close a credit card that has a balance, your total available credit is lowered to $0. Since you still have an unpaid balance on that credit card with a zero credit limit, it looks like you have maxed out that card.
So pay the lower balances off first and one at a time. Do not close out the only card with available credit. Closing out this card will decrease your total available credit and increase the amount of purchasing power you have.
Do not close out your only credit card. Since part of your credit score takes into consideration the different types of credit you have, keeping a credit card in the mix will add points to your credit score. You can be turned down for a credit card in the future because the creditor thinks you do not have enough experience with credit cards.
If you have a credit card that has a low interest rate, no annual fee, and other perks like travel insurance or rewards points, keep it. A credit card that charges you less for making purchases is far better than one that charges you more.
Lastly, closing out old credit cards shortens your credit history. Credit companies view borrowers with short credit histories as riskier than borrowers with longer histories.
Another way to help lower your debt ratio is to take advantage of balance transfers and introductory rates.
Search for cards that have the lowest APR, no annual fees and offer a 0% introductory rate for a year or for the longest period available. The thing to remember is to keep track of (x) what balance is where, and (y) how long you have before the zero percent rate ends.
You must make time to regularly review your financial picture regarding balances and payments in order to stay on top of the game.
Making this a part of your normal routine will keep the credit issue at the front of your financial thought process. Remember, the proper use of credit should work FOR you, not against you.
The bottom line is to be sure:
- Your debt-to-credit ratio is under 20%;
- You have an emergency back-up fund;
- You maintain your credit card balances within 50% of their limits; and
- You try to pay off your balance at the end of the month or at the very least make your minimum payments on time.
Using these measures will help you keep in good standing and make it easier to finance the finer things in life later on.