Imagine a brand new credit card with a spending limit of $5,000 just arrived in your mailbox. What do you do? If you’re like most, you activate it over the phone and immediately begin racking up credit card debt without ever considering whether the spending limit is reasonable for you. After all, the credit card issuer wouldn’t approve an amount more than you can afford to repay. Would it?
Before accepting your lender’s determination of your credit capacity, consider this easy-to-follow, three-step process to calculate how much credit card debt you can actually afford.
Step 1. Determine Your Payment
Your spending limit should depend less on your lender’s determination and more on your monthly budget. Take an honest look at your monthly budget and current expenses to determine the payment amount you can easily make every month.
Step 2. Apply the “20 Times” Rule
If your budget allows you to afford a monthly credit card payment of, for example, $50, apply the “20 times” rule to calculate your spending limit: Multiply your monthly payment ($50) times 20 to calculate your spending limit ($1,000). Go by this limit instead of your credit card’s maxed-out limit.
The beauty of the 20 times rule is that it ensures your payment will always be more than the minimum payment required, and it will keep the balance of your credit card debt in check. This makes it much easier to reduce or eradicate your debt entirely.
Step 3. Make Adjustments as Necessary
As your income grows and your ability to repay your debt increases, it is easy to increase your spending limit if needed, especially if your payments have been consistent and on time. It’s usually as simple as calling customer service or logging into your online account, answering a few questions about your current finances and getting a higher spending limit.
Remember, accepting a credit card means saddling yourself with potential long-term debt. There’s nothing wrong with having control over the amount you have to repay, but it’s easier to control this when you figure out what that amount is.