Maxing out a credit card means charging purchases on it until the balance is at the card's credit limit. In addition to potentially costing you hundreds or thousands of dollars in interest on the high balance, a maxed-out credit card could affect the rest of your financial life by lowering your credit score.
Why maxing out a credit card can be bad
The most obvious reason maxing out a credit card is a bad idea is the interest you'll pay if you carry the balance for some time. As an example, consider that a $5,000 credit card balance at 18% interest will cost $900 per year in interest charges alone.
The less obvious but perhaps more important reason that maxing out a credit card is bad is that doing so can damage your credit score.
To be clear, maxing out a credit card is unlikely to destroy your credit score all by itself, but it will certainly have a negative impact. To understand why, consider how your FICO score is calculated.
Credit card balances fall under the "amounts owed" category of the FICO formula, which makes up 30% of your score. This is certainly significant, but another way to think about this is that 70% of your FICO score doesn't depend on your account balances, which is why a maxed-out credit card is unlikely to have a devastating effect.
The amounts-owed category considers several factors, such as your credit utilization ratio -- the percentage of your credit limit you're using on each account -- and your overall credit utilization ratio -- how much of all of your available credit you're using. The category also considers some information that doesn't involve your credit limits, such as your current balances on loan accounts such as mortgages and auto loans. Because of the wide variety of possible information that can contribute to your FICO score, the effect of a maxed-out credit card can vary significantly.
Different situations produce different results
According to FICO, if you max out a credit card, you can expect a drop of 10 to 45 points in your FICO score, but this is a pretty wide range. The reason for the uncertainty is that every situation is different. Consider these two hypothetical scenarios:
- A consumer has a total of 12 credit cards with combined credit limits of $50,000, none of which has a carried balance. Since one of this person's cards with a $3,000 limit is offering excellent reward bonuses, he maxes out that individual card during the holiday shopping season.
- A consumer doesn't use credit cards often, so she has only one card with a $10,000 limit to be used in emergencies. She then gets sick and needs to max out the card to cover her medical bills.
In the first scenario, the consumer maxed out a credit card but is still only using 6% of his or her available credit. Therefore, while the maxed-out card could certainly ding his credit score, it's unlikely to have a dramatic effect.
On the other hand, the second consumer would probably experience a FICO score drop closer to the high end of the range. Not only will she have a maxed-out card, but she will be using all of her total available credit, which can be a much more serious issue in the eyes of the FICO formula.
In addition, FICO says the higher a consumer's score is to begin with, the larger the effect of a bad credit behavior such as a maxed-out card. FICO says a consumer with a score of 680 would experience a 10- to 30-point drop for maxing out a card, while someone with a 780 could see his or her score fall by 25 to 45 points for the same offense.
Is maxing out a credit card ever a good idea?
In most cases, maxing out a credit card is a bad idea, but just like pretty much everything other topic in personal finance, this isn't true in all situations.
Debt consolidation is one common example. There are several credit cards specifically designed for balance transfers that offer 0% intro APRs for as long as 21 months. If you use one of these to consolidate several high-interest credit cards into one account, it can certainly be worthwhile, even if the newly opened credit card ends up getting maxed out in the process.
Emergency situations are another common reason to max out credit cards, and many people only carry credit cards for this purpose. For example, if your car breaks down while you're hundreds of miles from home, it's not necessarily a bad move to charge the repairs to your credit card.
The bottom line on maxing out a credit card
Generally speaking, maxing out a credit card is bad for your credit score and your overall financial well-being, but there isn't a one-size-fits-all answer to the question "How bad is it to max out a credit card?" In some cases, it may be worth taking a small hit to your credit score, if you're using a newly maxed-out credit card to save hundreds or thousands of dollars in interest charges.
Having said that, be sure you know exactly what you're getting into if you max out one of your credit cards, both in terms of the potential hit to your credit score and the interest you can end up paying from your purchases.
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