Once balance is paid off, your credit limit is restored
Erica Sandberg is a prominent personal finance authority and author of “Expecting Money: The Essential Financial Plan for New and Growing Families.” She writes “Opening Credits,” a weekly reader Q&A column about issues for people who are new to credit, for CreditCards.com.
Dear Opening Credits,
I have a credit-builder card from my bank with a $2,000 credit line. I have already racked up a bill of $500 on purchases. When I pay that off, will my loan amount go back up to $2,000? – Tiffany
Thank you for asking this question because I want everybody to be perfectly clear on the way credit cards work. And just as importantly, how they’re reported to the credit reporting agencies and the effect they have on credit scores. So here is what you – and all cardholders – need to know.
Credit cards are equipped with a maximum amount that the cardholder can borrow. It’s called the credit limit. The issuer sets it based on factors such as the applicant’s income and credit rating, as well the company’s internal business demands. In the case of a credit-builder card, which is more commonly known as a secured card, your credit limit is typically set by a deposit you give the bank that serves as your credit line. These cards are great for people just starting out with credit or who have damaged credit and need to rebuild.
Once a card is active, you can choose to charge any amount up to the limit. When you do, the amount you can borrow is reduced by what you owe. Since the limit for your card is $2,000 and you've already used $500 of it, you have $1,500 available to you. If you pay the bill in full and by the due date, you will have the complete $2,000 at your disposal again.
Of course, one of the options with credit cards is that you can send partial payments and then push the remainder over to the next month. If you send at least the minimum requested amount, the account will remain in good standing. However, interest will be added to the debt. The higher the interest rate, the worse the fees. Although the credit limit will remain constant, the amount you can borrow is reduced by the balance plus the accumulated fees.
In general, it is best to only charge what you will completely repay before the due date. Yet it is remarkably simple to spend more than you can afford, especially when cash is tight. Then the credit limit set by the credit card company can be seductive.
Resist temptation. Always remember that card purchases will have to be paid off quickly or interest fees will be applied, making the debt more expensive. For credit cards, interest compounds. That means that interest is calculated on balances already increased by fees. Get caught in the trap of charging up to the maximum and then paying only the minimum and you’ll be looking at huge fees and a debt that can last for many years. If you spend up to the limit on this card and the APR is 21 percent, for example, it can take 10 years to delete by only paying the minimum and you’ll end up paying about $2,061 in interest! In addition, keeping your balances high doesn't bode well for your credit scores, either. Credit scoring formulas reward people who keep their balances low. The higher your balance, the more risky you look to lenders.
So, keep close track of all of your credit card purchases and stop charging when you've reached your personal limit. This is a figure you set, not a credit card issuer. Review your earnings and expenses so you’re clear on how much you can easily afford to repay by the due date.
A secured card is a great way to start building your credit – or rebuilding it if your credit has been in the dumps. When you charge with this card and stick to the payoff plan, your account activity should show up on your credit reports. The credit limit, current balance and payment pattern are listed. Just by using the card frequently, keeping the balance low and paying on time, will reflect well on your credit scores.
A long history of perfect payments and low credit utilization (which means keeping balances well below your credit limit) will translate into great credit scores – and credit cards with an even higher credit limit than you have today.
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