The Danger of Maxing Out Your Credit Cards

Doing some research for a larger story about the “damage points” associated with having a credit-related boo-boo, I stumbled on this important factoid: A consumer with excellent credit who maxes out a credit card will see a credit score drop of 25 to 45 points. In other words, someone with a superb 780 score could see that drop to 735. Ouch! How do I know this? Credit scoring company FICO says so.

In fact, the higher your starting score, the more a maxed-out card can hurt you. Someone with a so-so score of 680 stands to lose only 30 points, at most, says FICO.

What does this mean for you, today? Well, December gift-buying has almost certainly put an unusual strain on your credit cards. Holiday travel might be adding to that. I wouldn’t be surprised if you have no idea what your card’s credit limit is, or how close you are to it. In fact, the better you are at managing money, the less likely you are to have even thought about your credit limit. So it’s possible you are closer to the limit than you think. And if early January brings you a surprise pipe burst in the basement or a major car repair, perhaps you will unintentionally max out a card. And your score could get seriously punished for it. Even if you always pay your bill in full by the due date (that’s because most card issuers report balances around the statement closing date rather than the due date; though that can vary).

So you should probably think about taking the unusual step of spreading your credit card purchases around. Take stock of your credit card purchases right now and see how much headroom you have before hitting your credit limit. And when you do, plan for an emergency. It’s best if you don’t even let yourself get within 25% of your limit. Use a second card if you have to, or better yet, pay off some of the balance early if you have the cash in a savings account. Remember, you don’t have to wait until you receive your bill to send a partial payment to the credit card issuer.

Note: Since credit utilization is an important factor in score calculation, it is best to use only 10% to 20% of your card’s available credit at any given time if you want to help maximize your credit score. That 25% of your limit suggestion above is probably the upper limit.

How Long Does the Damage Last?

It’s important to keep the maxed-out penalty in perspective. The “damage” points are only about half as many as failing to pay a bill (having a “30-day delinquency”) on your credit report. For someone with nearly perfect credit, it wouldn’t be enough to knock them out of a prime loan. But it would eat up just about any buffer that person would have. And why take that risk? Even the most careful spenders can go a little crazy during the holidays. That’s OK. In fact, I think if you don’t, you’re probably a Scrooge. But even as your generosity is flowing, don’t risk maxing out your credit card. Otherwise, your holiday hangover could last a while. (You can get a free, personalized look at how your credit habits affect your scores on Credit.com.)

And there’s good news. It’s easier to recover from a maxed-out card than from a late payment, according to the folks at Fair Isaac. You just have to pay down your bill back to where your credit utilization normally is. Here’s the explanation from Jeffrey Scott, spokesman for Fair Isaac:

“The data fed by the bureaus into the FICO Score only contains card balance and card limit information for the most recently reported month,” he said. “So unlike a delinquency, which can remain on the credit file for up to seven years and therefore be factored into the FICO Score long after the event occurred, a maxed-out card only impacts the FICO Score for as long as the card remains maxed out. If one month the card is maxed out and the next month the card is paid down to just 10% utilization, the FICO Score for that next month will only be fed data indicating that the card is currently 10% utilized. The fact that the card was maxed out as recently as the prior month will not be apparent in the bureau data fed to the FICO Score.”