Credit card debt is a type of revolving debt. You can keep borrowing month after month as long as you repay enough that you never owe more than your credit limit. Credit card accounts can be used indefinitely, unlike installment loan accounts that are closed once the balance is paid off.
This type of debt can easily get ahead of you, however, wreaking havoc on your finances and your credit score. It's generally advised that you shouldn’t charge more than you can afford to repay at the end of each month, no matter how high your credit limit might be. You’re charged interest on the debt when you don't pay off your balance, and this will accumulate until you do so you can get even further behind.
What Is Credit Card Debt?
Credit cards were introduced in the 1950s, and the national debt balance steadily increased as they gained in popularity. Consumers reached for credit cards to cover expenses, and card debt soared after the Bankruptcy Protection Act made it more difficult for people to file for bankruptcy in 2005.
The U.S. revolving debt balance for consumers, which is largely made up of credit card debt, surpassed $1 trillion for the first time in December 2007. Then the prevalence of credit cards declined and balances dropped with the Great Recession. Laws like the CARD Act of 2009 were passed and the national revolving debt balance fell to $835.9 billion by April 2011.
It didn’t take long for Americans to start feeling comfortable borrowing again. The revolving debt balance is well over the $1 trillion thresholds again as of 2020. Credit card balances alone are back up to $930 billion, well above the previous peak reached in 2008. The average credit card balance was $6,194 in 2019.
Credit card debt is also more expensive to carry, thanks to the Fed's nine interest rate hikes between 2015 and 2018. The average APR is still more than 3 percentage points higher than it was in 2014 at 16.88%, even after the change in course. Two-thirds of active credit card accounts carry balances from month-to-month.
How Credit Card Debt Works
Credit card debt is unsecured. It’s not backed up by a piece of property, such as your auto or your home, that acts as collateral so the lender can claim it and sell it if a borrower stops making payments. Not repaying your credit card debt can nonetheless seriously damage your credit score and history.
You’ll accumulate credit card debt if you don't pay off your entire balance by the due date each month. Card balances carried month to month are charged interest in the form of an annual percentage rate (APR).
APRs vary greatly based on the type of card, the bank issuer, and the credit history of the cardholder.
Most credit card interest rates are variable. They're based on the prime rate, a prevailing rate that’s tied to the Federal Reserve’s benchmark fed funds rate. There's a ripple effect when the Fed raises or lowers this target rate, and the rate you pay—as well as the cost of your credit card debt—goes up or down accordingly.
Credit card issuers require that you make at least a minimum payment each month. It’s typically just a fraction of your balance, around 1% to 2%, plus interest charges and any fees that might apply.
You’ll be charged interest whenever you pay less than the full balance, and the less you pay, the more interest you’ll owe because credit card interest compounds. Interest accrues on interest. The longer it takes you to pay off the debt, the more likely it becomes that you'll owe far more than you originally charged on your card.
Disadvantages of Credit Card Debt
Contrary to popular belief, carrying credit card debt does not improve your credit score. Using credit wisely improves your score. This means charging only what you can afford to pay off each month, making on-time payments, and keeping your balances as close to zero as possible.
Consider what you’re giving up by paying interest on card debt every month rather than investing that money elsewhere. That money could be valuable savings for retirement, your emergency fund, or a down payment on a house.
Do I Have Too Much Credit Card Debt?
Any one of three formulas that can help you identify when you have too much credit card debt.
Your credit utilization ratio is your total credit card balance divided by your credit limit. It's the percentage of your available credit limits that you’re actually using. It has the second biggest impact on your credit score, right behind your payment history. The lower your credit utilization ratio, the better. A ratio greater than 30% will usually hurt your credit score.
Your debt-to-income ratio is your monthly debt and housing payments divided by your gross monthly income. Your debt-to-income ratio shows how much of your pre-tax income goes toward monthly housing and debt payments, including payments on credit cards. Lenders look at this ratio when they're reviewing new credit applications to determine how much more debt you can take on—or not take on.
A debt-to-income ratio greater than 40% indicates you have too much debt, and approval is unlikely. Many banks and credit counselors recommend keeping it closer to 30%.
Your credit card debt ratio is your total monthly credit card payments divided by your total monthly income. This ratio tells you when your payments are too much for your budget. Paying for routine expenses and necessities can become difficult if your minimum required payments are more than 10% of your take-home income pay after taxes are withheld.
There are also some non-mathematical signs that you might be overwhelmed with credit card debt:
- You spend more overall each month than you earn.
- You’re missing or making late payments on credit card accounts to afford other bills.
- You’ve used one credit card to pay another.
- You rely on credit cards to afford daily purchases like gas and groceries.
- You're making credit card payments instead of adding money to a savings account each month.
- You’ve considered filing for bankruptcy.
How to Control Credit Card Debt
Credit cards can be a useful financial tool despite their downsides, and they can improve your credit score when used wisely and if you take precautions.
Learn as much as you can about your current credit cards and any you want to apply for. Review the card issuer webpages carefully, comparing credit card terms and conditions and benefit guides. Knowing how and when you’ll pay will help you use credit wisely.
Establish spending rules for your cards and stick to them. For example, only use your credit card for groceries or routine car maintenance—both expenses your budget should already support.
Prevent credit card debt by establishing in advance how much you can charge each month. Make sure you base that figure on what your bank account shows you can afford.
Credit cards aren't an excuse to go on a shopping spree. They're not "extra" money. Live within your means and only use your cards to pay for things that you could also pay for with cash or your debit card.
You’ll face late fees and interest charges if you don't pay on time. Your card issuer might also raise your APR to the penalty rate outlined in your card’s terms and conditions, depending on how late you pay. Set up calendar alerts or automatic payments if you have trouble remembering due dates.
Keep tabs on your spending by checking your credit card accounts each week. Seeing how quickly charges can add up and consume a credit limit might inspire you to pay off the balance more quickly.
Avoid taking cash advances. Using a credit card for a cash advance means paying higher interest charges and transaction fees, and these transactions typically don’t have a grace period. Interest is charged starting the day you take out the advance, not when the billing cycle closes.
Don’t open new cards on a whim. Having a wallet full of cards can encourage excess spending, and it can make it hard to keep track of where your money is going. Focus on using cards that work well with your existing spending habits.
Check your credit report periodically. It will show the debts you owe, your repayment history, the number of inquiries on your accounts, and what types of credit you're managing.
Lenders use credit reports to gauge your creditworthiness, and you can do the same. You’re entitled to a free copy of your credit report from each major credit bureau every year via AnnualCreditReport.com.
Connect with a non-profit credit counseling service that can offer advice if you feel overwhelmed. Reach out to your card issuers if you have questions or concerns. Don’t wait until accounts fall delinquent.
- You can borrow on a credit card repeatedly, up to the amount of your available credit.
- Your available credit is the difference between your card’s credit limit and how much you’ve already charged, plus interest and fees.
- Credit card debt isn’t secured by collateral. The lender can’t seize property that you’ve purchased if you fail to pay your card balance, but your credit score can nonetheless be seriously damaged.
- You don’t have to pay off your entire card balance each month, but you’ll accrue interest on interest if you don’t because interest compounds on balances. Your debt will increase.