Though credit cards can be a great credit resource if used wisely, their negative impact on the amount of money you can borrow cannot be overlooked.
Even if you don’t use them frequently, having a credit card is generally seen as a liability especially when it comes to how much you can borrow.
Consider this scenario: you want to borrow money to buy a house, but your credit card limits are $20,000. This could potentially reduce the amount you can borrow by $100,000.
Having a credit card, even though you may not use it, will usually be viewed as a liability by banks and lenders.
This is because they factor in the full limit when determining your borrowing capacity, which can limit your ability to obtain a loan for the amount you require.
Despite any efforts to prevent the use of your credit card, even if you were to keep it frozen in a in a block of ice in the freezer and maintaining a $0 balance, banks and lenders will still hold you responsible for the full limit as a liability.
Because you can go out and use the available credit at any time.
If you are a first home buyer, it is essential to understand the implications of this, so let’s delve deeper into what it means for you.
In order to determine the minimum monthly repayment on a credit card with a limit of $20,000, most Banks and Lenders utilize a formula that involves multiplying the credit limit by 3.8%, which amounts to a monthly repayment of $760 or an annual repayment of $9,120.
This is regardless of whether or not you choose to pay off your credit card balance entirely every month.
In order to determine your borrowing capacity, lenders will assess various factors, including your credit card limit.
For instance, if you have a $20,000 credit card limit, the lenders will consider the cost of maintaining it, which amounts to $9,120 per year or $760 per month in repayments.
The impact of this can be enormous, as you can see for yourself. If you are looking to increase your borrowing capacity, one suggestion you may wish to think about is to consider reducing the number of credit cards and or credit card limits or perhaps you may even get rid of them altogether if they are not necessary.
Although it may seem like free money, in reality, it is not. Credit cards come at a cost.
The interest rates are generally quite high, as is often the case.
In case you can’t avoid getting a credit card, it may be advisable to choose one with a low credit limit and make sure you pay it off monthly, this way you can avoid paying interest on the outstanding balance.
If you must have a credit card, it is important to select a card with a manageable monthly payment, so that if you need to make purchases, you will have the credit card available which you can comfortably pay it off each month.
In conclusion, understanding this key concept is essential, debt can be beneficial if used wisely.