The Dangers of Being Over-Leveraged

It’s not always easy to manage your money — you know this. When life becomes complicated with issues such as job loss, illness, a reduction in income, or even just plain bad budgeting and overspending, then the task of managing your household finances can become even more difficult than usual.

Unfortunately, if you fail to take control of your spending and debt, then at some point the situation may begin to control you — and that’s where it gets really expensive.

The Cost of Being Over-Leveraged

It’s not at all uncommon for people to turn to their credit card accounts whenever financial difficulties arise. If you’ve ever found yourself in the uncomfortable position of having more bills due than money available, then you may be all too familiar with this reality. After all, it’s extremely easy to pull out a little plastic to cover your gas or groceries for the week, the month, or even longer whenever you find yourself without sufficient funds to cover your family’s day-to-day expenses.

However, if you fall into the regular habit of charging more than you can afford to pay off in full each month, you may quickly become in danger of being financially overextended. And you wouldn’t be the only one: American consumers carried a total of $999.7 billion in credit card debt in August 2017, according to the Federal Reserve; we haven’t been that reliant on revolving credit since January 2009.

Certainly, the best way to manage your credit card accounts is to avoid charging more than you can afford to pay off in any given month. When you begin to consistently charge more than you can afford to pay off, your credit card debt will inevitably grow. This problem is compounded even further when expensive interest gets tacked onto your climbing credit card balances each month.

Leveraging the available funds on your credit card accounts may offer you some immediate relief from your financial woes. However, if you don’t quickly regain control of the situation, the truth is that your money problems are growing at about 17% APR, as that’s the average interest rate on general use credit cards.

The Toll on Your Credit Scores

All that interest means you’re wasting a ton of money if you’re taking on too much credit card debt, and putting yourself in an ever more precarious financial position. What you may not realize, however, is the damage large credit card balances inflict on your credit scores. Neither are easy to reverse, unless you can write a big check.

Credit scoring models like FICO and VantageScore are designed to pay a lot of attention to a credit file attribute known as your revolving utilization ratio. Revolving utilization describes the relationship between your credit card balances and your credit limits, expressed as a percentage. As the balances on your credit card accounts increase, so does your revolving utilization ratio. Here is how it’s calculated:

• Credit limit: $5,000
• Credit card balance: $2,500
• $2,500 (balance) ÷ $5,000 (limit) = 0.5 x 100 = 50% utilization

When being over leveraged financially causes you to increase your credit card balances month after month, your revolving utilization ratios are going to climb. That’s a mathematical certainty.

Unfortunately, this means that credit scoring models will generally award you fewer and fewer points as those revolving utilization ratios increase.

The result of this behavior will almost certainly be a negative impact on your credit scores. The bad news is that as your credit scores decline from an increase in credit card utilization, you may actually begin to unintentionally waste even more of your hard earned money — because your other credit card issuers can increase your interest rates as a way to mitigate against your risk. Any increased rates can be applied to new purchases that postdate the increase.

The moral of the story is that there’s nothing good about being over-leveraged. It’s expensive — which makes it that much harder to get back to financial stability. Your alternatives are also lousy, as they include debt management programs, debt settlement, and, yes, bankruptcy.

Related Articles: 

• Does Taking on More Debt Increase Your Credit Score?
• Here’s How Much the Average American Pays in Interest Every Year
• Should You Use a Personal Loan to Pay Off Credit Card Debt?
• Two-Sided Coin: Is Debt the Devil?

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