Credit cards are a necessary evil of the 21st century. Whether you use them for monthly expenses and pay off the balance every month or reserve them for emergencies and let the balance slip away from you until it seems like a mountainous debt, it's rare to find someone who doesn't own a card. Maxing out a card hurts your credit score and can affect your ability to get a loan.
Being over the limit on your credit card can severely affect your credit score, the snapshot of your credit that lenders look at when deciding whether to lend you money and at what rate. Your credit score is a mashup of different factors in your creadit report, one of which is the amount you owe. FICO, for example, factors in the amount you owe as about 30 percent of your credit score -- and that factor includes your utilization, which is how much you owe compared to your credit limit. The closer you get to your limit, the more your utilization hurts your score. There is no way to know exactly how far your score will drop, because credit scoring companies keep their computing formula under tight lock and key.
How Low to Keep Your Debt
It's a good rule of thumb to keep your credit card balances at 50 percent or lower of your total available credit, according to FICO. Anytime you go over that ratio, your score can inch down. If potential lenders spot cards that are maxed out or over the limit, they'll take that as a sign you're living beyond your means. And that can make them reluctant to lend you the money to buy a car because they are afraid you are already overextended.
How This Affects Your Loan
Lenders look at your income, job history and credit score to determine whether you will be able to pay the loan back. An over-limit credit card will affect both your score and the lender's faith that you're financially stable enough to pay back the loan. This can mean that the lender will turn you down for the loan entirely. On the other hand, the lender may decide to give you a loan but to charge you an astronomical interest rate for the privilege. According to FICO, which analyzed the national average of car loans at 2012 rates, someone with a FICO score above 720 will qualify for a car loan at about 3.5%, but with a FICO score under 660, the interest rate will be in the double digits.
The Bottom Line
It boils down to this: if you're over the limit on your cards and seeking an automobile loan, it may be time to step back and analyze your financial situation. Are you living beyond your means and using credit cards to subsidize your monthly expenses? If this is true, getting new wheels may not be the optimal choice right now. Instead, work on getting your financial ducks in a row and paying down your credit card balances. The bright side is that when you're ready to go back in and secure financing for your new car, you'll probably be rewarded with a lower interest rate to go along with your new and improved credit score.
Lisa Carlson works as an associate director of recruitment and graduate programs at a public university, and has experience in management, marketing, personal finance and nonprofit organizations. She is a peer-reviewed author on publications for higher education recruiting and holds a B.S. in marketing and a M.B.A.