A little credit history (pun intended). Charg-It, one of the first credit cards in the United States was started in 1946 by a Brooklyn banker kicking off the credit card craze that would engulf the world. The 1950’s saw the introduction of the modern credit structure seen today. With Bank of America being the first to introduce revolving credit in 1958. American Express would introduce the first plastic credit card in 1959, before then credit cards were made of stiff cardboard or celluloid.
Over the last five plus decades, credit cards have evolved to become a staple in American finances. Sadly, too many people find themselves in a credit card cloud not knowing the best way to manage credit. For the purpose of this article we will primarily be talking about revolving credit.
Managing credit is difficult enough, managing credit cards is even harder, why? The answer is simple, no one really explained how it all works together. I remember when I received my first credit card, all my parents said was don’t go crazy; I should have listened. Now that I am older, and hopefully wiser, I have learned a few things about credit and credit cards I wish someone would have told me. So, without further ado.
One-Third and the 30% rule
Credit cards have limits, duh! Having lots of credit cards, especially some with high credit limits is bad, why? The total amount of revolving credit should not exceed your annual income. Even if your actual revolving debt is low doing so could put you at risk for default in the eyes of future creditors. Managing your overall revolving credit is critical to raising and maintaining a high credit score. So, the first rule, keep your total revolving credit to one-third of your gross annual income.
Next, keep your total revolving debt to within 30% of the total amount of revolving credit. So, if you have a total of $10,000 in revolving credit you should keep your total revolving debt to $3000 or less. Wait, that can’t be right?! Why so low? The answer comes down to individual credit cards.
For each individual credit card, it is best to keep your total balance owed to 30% or less of the credit limit. This is important because anything above 30% starts to impact your credit score. At 50% and higher the impact to your credit score is substantial. When you factor in multiple credit cards it is easy to see how things can add up quickly.
As a side note carrying a balance across multiple cards may work to keep you in line with the 30% rule, but when a future creditor reviews your credit history it could be counted against you.
It adds up against you
Here is a simple example. If your annual income is $60k then your total revolving credit should be one-third or $20k. Applying the 30% rule to $20k amounts to $6000 usable credit. Spread $20k across five credit cards with the following credit limits; $1500, $2000, $3500, $5500, and $7500. Now apply the 30% rule for each credit card and you get the following; $450, $600, $1050, $1650, and $2250 totaling $6000.
Even though the amounts for each card is small, they add up to 30% of the total revolving credit. Lose track of your credit card usage and you are at 50% of your credit limit quickly. I know this doesn’t make sense, why have all this credit if I can’t use it? The answer is simple, it is a game where the odds are against you. What creditors and credit reporting algorithms look for is reasonable credit card use with plenty of additional credit to spare.
Unfortunately, all this is a double edge sword. If one credit card has a balance 30% to 50% it will impact your credit score. If your overall total revolving debt exceeds 30% it will impact your credit score. And, if both occur your credit score will take a nosedive. Keep in mind the 30% rule is based on the maximum balance carried on each credit card relative to the credit limit. Ideally, according to Credit Karma, credit card usage should be below 10% overall.
Don’t forget the pay back!
Credit cards act as mini-loans, and every loan needs to be paid back. Having balances on multiple credit cards can be expensive. The average monthly credit card payment is between 2% and 3% of the average daily balance. This is another factor to use the 30%, to keep your monthly payments reasonable. If your shelling out lots of money on credit card payments, it could be a strike against you when applying for additional credit.
The main takeaway here is to keep your total revolving credit and debt reasonable. Credit Karma has some very good tools to help manage credit card debt and credit overall. If you find yourself pushing the 30% rule whether on one credit card or the total amount of revolving credit it is a good idea to stop, evaluate, and make changes before it is too late.