There are many factors to consider when deciding which credit card to choose from a range of available options. In our today’s article we will focus our attention on ideal credit card limit for you.

Choosing the right credit limit is the most important thing that may determine future cost of running your credit card account. It is tempting to apply for a high credit limit, but this may prove too costly in the future. The ideal credit card limit equals to the amount of “After cash money” one person has available each month. After cash money can be calculated simply by taking the total monthly net income and subtracting all payments which must be made in form of cash, direct debit, automated payment or bank transfer. Such payments usually include rent payments, mortgage payments, repayments of other loans, kids’ pocket money, your pocket money, school donations, savings, etc.

Example:

Net monthly income

$4,000

Monthly rent

-$1,000

Other Loan repayments

-$300

Pocket money

-$200

Donations

-$100

Other cash payments

-$200

Savings

-$400

After cash money

$1,800

 

All other payments that can be made by credit card usually include items like grocery shopping in supermarkets, restaurants, bars, electricity bills, phone bills, insurance, etc. The assumption here is that all these payments can be paid directly by credit card without taking money from ATM machines in form of cash advances (otherwise they would incur fees and interest).

Example:

After cash money

$1,800

Grocery shopping

-$800

Electricity bill

-$100

Phone bill

-$50

Insurances

-$100

Restaurants

-$200

Petrol

-$100

Clothing

-$200

Other expenses

-$250

Balance

$0

 

Now, the main point:

If your credit card limit remains at or below the “after cash money” point, you should be able to easily pay off the whole credit card balance each month without incurring interest.

If you for example applied for higher credit limit $3,000 ($1,200 above your “after cash money”) then you will be easily tempted to buy some extra treats with that “available money” on your credit card. It can be anything like new clothes, shoes or the latest iPhone. Even if you are disciplined, sooner or later you will surrender to your desires. Eventually, if not yours then your spouse’s or kid’s. Before long you find yourself in a situation that by the due date you won’t have enough money to pay the whole balance of $2,900. That’s because your “after cash money” is just $1,800. So, you pay just $1,800.

However, because you didn’t pay the whole balance, your credit card account will start incurring interest. And it will be interest for $2,900, not just for the unpaid balance of $1,100. Banks calculate interest from the date of purchase until you make the credit card monthly repayment.

Let’s say your average credit card balance during that period was $2,400 and your credit card interest rate is 20% p.a. This means that from now on you will be paying monthly interest $40. That’s $480 per year, until you start repaying your monthly balance in full and this may take a very long time.

Was that new iPhone for $1,000 really worth it? It didn’t cost you just $1,000 but another $480 in interest. That’s 48% interest per year (not 20% because you pay interest also for your all other credit card spending). Frankly, it was very expensive purchase!

So, the conclusion is:

Never agree to higher credit card limit than what you can repay with your available “after cash money” each month.

Posted on: September 13, 2013
Categories: Articles

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