The Hidden Value of Keeping Your Credit Card Limits Low

Credit cards come with plenty of perks, making them a convenient tool for everyday spending. But what many people don’t realise is that they can quietly affect your borrowing power. Let’s start off by exploring the benefits of having a credit card, as well as some hidden drawbacks you should be aware of.

Key Benefits of Credit Cards:

• Immediate access to more funds
• Interest-free periods of up to 55 days which can help maximise your cash flow
• Take advantage of reward programs linked to your credit card
• Paying for daily expenses and using the interest-free period will mean your funds kept in a savings account can be working in your favour, such as gaining interest 

Risks of Credit Cards:

• Having a higher credit card limit can make it easier to overspend. A lower limit reduces that temptation while still giving you a safety buffer.
• Increasing your credit card limit might affect your ability to borrow elsewhere

• Most lenders look at your credit card limits (not just what you currently owe) when deciding how much to lend you. Even if you don’t use your full limit, a high one can lead to smaller loan offers or a declined application.

The Impact Credit Cards Have on Borrowing Power

Lenders often consider your available credit when calculating how much you can borrow, because high credit limits can indicate potential future debt. When you apply for a loan, lenders look at how much credit you already have. Even if you haven’t spent it, they assume you could spend it in the future. To protect themselves, lenders often subtract a multiple of your credit limits from the amount they’re willing to lend you.

Your credit limit multiplied by five is a rough estimate of how much it could reduce your borrowing power or affordability when applying for a loan. This is also known as the 5× the credit limit.

The ‘5× Credit Limit’ Rule

If you have a $10,000 credit card, it could reduce your maximum home loan by about $50,000. How is that calculated? Multiply your credit limit by 5:

$10,000 × 5 = $50,000

So, if a lender originally thought you could borrow $500,000 for a home, your available credit of $10,000 might reduce that to around $450,000. Why? Because the lender assumes that in the future, you might use that credit, and it counts as potential debt.

When to Consider Closing Your Credit Card

It’s important to know that an unused card isn’t free in lenders’ eyes. A lender might treat your credit limit as if it’s debt, which can actually lower your borrowing capacity. If you don’t use your credit card daily, are looking to maximise your affordability, and want to remove “hidden debt”, it might be time to consider closing your credit card.  Alternatively, you could decrease your credit card limit to help prevent extra interest and debt piling up in the future, saving you from reaching a point where it’s unmanageable. 

Curious to Learn More?

Our friendly team of mortgage brokers are here to guide and support you, so you can make informed, confident decisions regarding your finances.

Let’s book a quick chat to see where you’re at today.