Let The Dominoes Fall
So, what exactly would happen if you run up your credit cards. The reason for the maxing out of your plastic does not matter. You could have gotten into financial trouble or perhaps just acted irresponsibly. No matter the cause for your credit cards being maxed out, the results are almost always the same. Take a look.
First, Your Credit Rating Will Drop
The second biggest factor determining your credit score is credit utilization. It is very important and makes up about 30 percent of your score.
Credit utilization is how much of you credit that you are using. To be doing good in this category, you should be using less than 30 percent of your credit. If you want to be doing excellent, you need to be using less than 10 percent of your credit.
The damage done by high credit utilization is incremental. The further that you get from 10 percent, the lower your credit score will drop.
Second, Your Credit Limits Will Be Reduced
Credit card companies monitor your credit to make sure that you continue to be a good risk. Just because you have a card with a 10,000 dollar limit does not mean that you will always have that limit.
When these companies start seeing your utilization increase, it is a red flag that things are not well. They will then start decreasing their exposure to risk by lowering your credit card limits. In turn that lowers your available credit, thus increasing your credit utilization even further. The result, is another decrease in your credit score.
Third, Accounts Will Be Closed
Let’s say that you have a few accounts that you have not touched. These might be store accounts or a single credit card that you were saving for an emergency. As your credit score continues to plummet, these companies will seek to cut their risk. To do that, they will likely cancel any accounts with a zero balance.
Once these accounts are closed, your available credit will once again be reduced. That will again result in an increase in credit utilization and possibly a reduction in credit diversity. The result, you guessed it, a decrease in your credit score.
Picking Up The Pieces
As you can see, charging up your credit cards can have a massive impact on your credit score and financial picture. Hopefully, you have will never have to deal with this issue, but if it happens, can you recover?
Recovery is absolutely possible. You just need to avoid making any late payments and pay off that debt. To do that successfully, most people do better with a plan. The two most popular debt reduction plans are the Debt Snowball and Debt Avalanche methods.
Debt Snowball Method
With this method, you want to pay off the lowest balance credit card first. The theory is that in doing so, you will have a card completely paid off quickly. That will motivate you to keep the process going.
To get started, organize all of your credit cards by balance. Then, pay the minimum on all cards except the one with the lowest balance. On this card, pay as much as you can afford to pay. Once it is paid off, simply move on to the next lowest balance.
Debt Avalanche Method
Debt Avalanche is all about maximizing your money. With this method, you pay off the highest interest debt first. This will use your money in the most effective way, reducing the amount of interest that you pay. The catch is that it might not be as motivating because your highest interest card could be one with a high balance. That means that it could take longer to get the satisfaction of a paid off credit card.
If this is the method you like best, organize your credit cards by interest rate. Then pay the minimum on all cards except the highest interest one. Pay as much as you can afford on it until it is paid in full. Then, move on to the next highest.
Avoiding The Dominoes Entirely
Wouldn’t it be great to never get into this kind of trouble in the first place? There are many things that you can do to keep yourself from dealing with the dominoes at all.
Have A Budget
Many people get into trouble because they simply do not have a budget. They spend without thinking about what they can and can not afford. This often leads to using credit cards to make ends meet and to cover normal every day expenses.
A budget can solve this problem by keeping you living within your means. If you do not have a budget, get one ASAP. It doesn’t have to be anything fancy. Just a list of all your expenses including categories for entertainment, food, gas, etc. Once you have your budget, you can compare it to your take home pay and make the cuts needed to live within your means.
Start An Emergency Savings
An emergency savings can help you ride a financial storm. It will give you the money needed in an emergency, allowing you to avoid dipping into your credit accounts. You should ideally have 6 months worth of expenses in your emergency savings. While that might seem like a lot, you can do it if you focus on small goals.
If your expenses are 4000 dollars a month, you should have 24,000 dollars in your savings account. That is a lot of money and a tough goal to reach. First, focus on saving 1000 dollars and then gradually increase your goal until you hit your final target.
Americans in general lack financial discipline and it tends to get us in trouble. We want what we want and demand immediate gratification. The credit card industry has taken full advantage of this fact.
Much of staying out of credit card debt is simply being disciplined. Implement some financial rules and stick to them. The 48 hour rule is a great place to start. If you decide that you want to buy something new, wait 2 full days and then re-access the situation. You will likely find that you no longer want the item and will have spared yourself an unnecessarily expense.