How to Choose the Right Credit Limit

As it may be flattering when a card issuer has given you a high credit limit, that does not mean that you have to accept it. Being new to credit cards or not having a steady income can create issues whenever it comes time to pay your credit card bill. With a higher credit limit, you can be tempted to charge more than you could possibly pay off. So how do you decide what limits you should have for a credit card? A good rule of thumb is to do what is called the “20-10 rule of limiting debt.”

What is that is the 20-10 rule?

You should never borrow more than 20% of your yearly net income (money after taxes) and your payments shouldn’t exceed 10% of that monthly net income. It is really that simple and here is an example on how to figure this out in your own life.

If your net income is $500 a month, you would multiply that by 12 months to find that your annual net income.
$500 x 12= $6000.

Then you would calculate 20% of that amount and use that as your limit of what to borrow.
$6000 x 20% = $1200 credit limit (So, you will never want more than $1200 outstanding in debt and this is a good idea of what you should set as a credit limit.)

Also, you would not want your monthly payments to be more than 10% of your monthly take home pay. Starting again with your $500 a month of net income, you would calculate what 10% of that would be and you would not want to exceed that in monthly payments.
$500 x 10% = $50 per month

Having these rules will help to ensure that you will be able to pay off your bills on any loan (yes, a credit card is a type of a loan) that you sign up for, but a good idea to gauge your credit limit. You can always adjust the credit limit later down the line if needed, but these rules will always help at any point in your life.

Source: Lesson 4: Credit Cards/Practical Money Skills for Life  <https://www.practicalmoneyskills.com/foreducators/lesson_plans/college.php>

 

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