When a bank issues your credit card, it specifies a dollar limit, which you should not exceed. Unfortunately, many cardholders spend over their monthly limit without realizing the negative consequences that this can have.
In fact, you may be penalized even if you just come close to your limit without actually exceeding it. While this may not seem fair, it is the way credit card companies work.
The reason that card companies do not want you to go over-limit or even close to the maximum amount that you are allowed to spend, is that their experience shows that customers who max out their cards are poor credit risks. In other words, such cardholders have a higher chance of defaulting than those who utilize only a small portion of their card limit.
What exactly happens when you exceed your credit limit? Can you take any steps to avoid the problems that arise?
You will have to pay an over-limit fee
The first action that a bank will take when you exceed your credit limit is that it will charge you an “over-limit” fee.
You will have to pay a sum of about $30 for the privilege of spending in excess of your pre-decided maximum monthly credit amount. Your credit card agreement and your monthly statement clearly specify the fee that you will be charged. Most people do not read these documents carefully. As a result, they get an unpleasant surprise when they notice the penalty that has been imposed.
Your credit score can drop
This is probably the most serious consequence of going over-limit. Although there is no immediate financial implication, a lower credit score can harm you in many ways. You would find it more difficult to get a loan and would also need to pay a higher rate of interest to most of the financial institutions that you borrow from.
If you exceed your card limit only once and subsequently pay your outstanding balance, the impact on your credit score will be negligible. But if you are constantly at or above the maximum amount that you are allowed to have outstanding, expect your credit score to be negatively impacted.
According to Experian, one of the credit bureaus who provides information that goes into making your FICO score, exceeding your credit limit is a serious matter.
In a blog titled, The Impact of Exceeding Your Credit Limit, Experian advises cardholders, “You decide how you use your credit cards, and you suffer the consequences if your decisions abuse the privilege of using those cards. Exceeding your credit limit is abusing that privilege.”
Is it ok to exceed your credit limit if you pay off the entire balance in the next billing cycle?
Unfortunately, the credit bureaus do not consider this to be prudent financial behavior. The credit card company has set a limit for you based on their judgment of your credit worthiness. Effectively, there is a legal agreement between you and the credit card issuer, which stipulates a maximum monetary exposure.
When your balance exceeds this sum, it raises a red flag in the credit card issuer’s records. Consequently, the information that they furnish to the credit bureau shows that your current balance exceeds your credit limit.
The calculation of your credit score considers your balance in relation to your limit. As your records will clearly show that you are over-limit, you can expect your credit score to decline.
Maxing out one card is bad enough. But if you max out all your cards, you can be sure that you will do great harm to your credit score. Remember that 30% of your score is based on how much of your available credit you are using.
Your interest rate can go up
If you regularly exceed your limit, be prepared to pay a higher rate of interest on your outstanding balances.
The credit card company takes this step for two reasons. One, it wants to discourage cardholders from going over-limit. The second reason is that a person in this category is more likely to default. Raising the interest rate compensates the lender for the losses that it could incur.
Many credit card companies have internal norms that trigger their penalty rate if you default on the terms that you have agreed to when your card was issued. The penalty rate is the highest rate that the card issuer can charge. It could be 30% or even more on a yearly basis.
There are various types of protection offered to consumers under the Credit Card Accountability Responsibility and Disclosure Act of 2009, commonly called the CARD Act. But this federal legislation does not cap the interest rate that cardholders can be charged by credit card issuers.
Your balance will become harder to repay
Spending on your credit card is deceptively easy. You can do it even if you do not have the money to repay when your credit period expires. This is because you know that when your monthly statement arrives, you have the option of paying a small percentage of the outstanding amount and rolling the balance over to the following months.
In fact, many people use this facility on a regular basis. They make purchases, but pay only 5% or even less of their monthly bill amount. While using a credit card in this manner can provide great benefits, it is not without its risks.
If you keep making purchases and paying only the minimum amount permissible, you could soon find yourself in a situation from which it will be difficult to extricate yourself. Even worse, if you exceed the limit on your card, your balance would balloon even more.
Going over-limit has a cascading effect on your finances. In addition to the purchase itself, you need to pay more in the form of over-limit fees and a higher interest rate. It could take you many months to get out of this situation.
Your credit card no longer serves its original purpose
Do you remember why you got your credit card in the first place? One of the main reasons was to give you the flexibility to spend when you did not have money in the bank. If your card remains over-limit, you will be unable to use it any longer.
To avoid landing in a position like this, keep your total outstanding amount at least 10% below the maximum allowed. Doing this will let you go on using your card as you work to gradually reduce your balance.
You can ask for a temporary increase in your credit card limit
If you are in a situation where you want to make a purchase but find that you do not have a sufficient unutilized balance on your credit card, there is a solution. Simply call your card issuer and request a temporary increase in the maximum outstanding balance that you are allowed under the terms of your card agreement.
Those cardholders who have a long-standing association with the card issuer and a good payment record can expect a positive answer to their request. Using this technique helps you in two ways. Firstly, your record will not show that you have spent over the maximum permissible amount.
Another advantage that you will get by requesting the card issuer for a temporary enhancement is that you will not be charged an over-limit fee.
Here’s what to do if you inadvertently exceed your credit limit
If it is the first time that you have gone over-limit you can approach your credit card company to waive the over-limit fee. You stand a better chance of having your request accepted if you have been a customer for many years and have always paid on time.
It is likely that the credit card issuer will accede to your request if you can explain that you went over-limit by error. Next, you should immediately make a payment to decrease your balance. Do not wait for your monthly statement. Bring your balance down as soon as you can.
Reducing your balance will result in a lower interest charge. Additionally, the credit card company will not continue to charge over-limit fees every month.
What can you do to avoid the negative implications of going over-limit?
If you regularly exceed your credit card limit, there are a number of negative consequences. The higher interest rate that you pay on your outstanding balances would be a strain on your finances. The over-limit fees would add to your financial woes.
A cardholder who is in such a situation should immediately start tracking the credit card purchases made every month. Maintain a list of the expenses that you plan to charge to your card and ensure that the total outstanding amount is within the maximum that you are allowed.
When you are doing this exercise don’t forget to add your existing outstanding balance and the interest that you will be charged on it. It is also a good idea to sign up for free email alerts that will inform you of the amount that is being spent on your card.
If you do this exercise diligently and monitor the amount that you are spending on your credit card, it is possible to ensure that you never go over-limit again.