What Is Credit Card Debt and How Can You Avoid It?

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Credit card debt can quickly get ahead of you and wreak havoc on your finances and credit score. No matter how high your credit limit, you shouldn’t charge more than you can afford to repay at the end of each month. When you don’t pay off your balance, you’re charged interest on the debt, and you can get even further behind.

Luckily, all you need is discipline to avoid credit card debt. Here’s a primer on how the debt grows and 10 tips to fend it off in your household.

What Is Credit Card Debt?

Credit card debt is a type of revolving debt, which means you can keep borrowing month after month, as long as you repay enough that you never owe more than a set limit. Credit card accounts can be used indefinitely, unlike installment loan accounts, which are closed once the balance is paid off.

Credit card debt is also unsecured, which means it’s not backed up by a piece of property (like your home) that can be seized if you stop making payments. Still, not repaying your credit card debt can seriously damage your credit score and history.

How You Accumulate Credit Card Debt

If you don’t pay off your entire balance by the due date each month, you’ll accumulate credit card debt. 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, which means they are based on the prime rate, a prevailing rate that’s tied to the Federal Reserve’s benchmark rate.

When the Fed raises or lowers its target rate, there is a ripple effect, and the rate you pay—and your credit card debt—go up or down accordingly. In recent years, the average rate on credit cards that charged interest has risen along with the Fed’s rate and now stands at 17.14%. (See chart below.)

In July 2019, the Fed had its first rate cut in more than a decade.     

How Credit Card Debt Compounds

Credit card issuers require you to make a minimum payment each month. It’s typically just a fraction of your balance (often around 1%-2%) plus interest charges and any fees that might apply.

Whenever you pay less than the full balance, you’ll be charged interest, and the less you pay, the more interest you’ll owe. This is because credit card interest compounds, meaning interest will accrue on interest. The longer it takes you to pay off the debt, the more likely you are to owe far more than you originally charged on your card. The chart here illustrates this:

A Brief History of Credit Card Debt

Pre-2009

Credit cards were introduced in the 1950s, and not surprisingly, the national debt balance steadily increased as they gained in popularity. After the Bankruptcy Protection Act of 2005 made it more difficult for people to file for bankruptcy, consumers reached for credit cards to cover expenses and card debt soared. 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. 

Debt During the Great Recession: 2009-2011

As consumers felt the repercussions of the Great Recession, and laws like the CARD Act of 2009 were passed, the prevalence of credit cards declined and debt balances dropped. By April 2011, the national revolving debt balance had fallen as low as $835.9 billion. 

Debt Today

It didn’t take long for Americans to feel comfortable borrowing again. Almost 10 years after the peak of the financial crisis, the revolving debt balance is well over the $1 trillion threshold again. (See chart below.) Credit card balances alone are back up to $868 billion, just about at the peak level reached in 2008.  The average credit card balance was $6,028 in the first quarter of 2019. 

Credit card debt is also more expensive after the Federal Reserve passed nine interest rate hikes since 2015. At 17.14%, the average APR is nearly 4 percentage points higher than in 2014. It certainly doesn’t help that almost half of credit card holders (44.5%) carry balances month-to-month.

Credit Card Debt is Not Good Debt

Contrary to popular belief, carrying credit card debt does not improve your credit score. Using credit wisely does. That means charging only what you can afford each month, making on-time payments, and keeping your balances as close to zero as possible, if not zero.  

While monthly credit card payments are often smaller than the required payments on auto loans or other debt, you shouldn’t carry a balance just because you can afford to make the minimum payments.

Consider what you’re giving up by paying interest on card debt. That money could be valuable savings for retirement, your emergency fund, or a down payment on a house.

To be clear, it’s not bad to use credit cards. It’s bad when you borrow more than you can afford to pay back.

And even that is a grey area. Some people may need a few months to catch up on their bills due to an unforeseen event, and some may routinely run a low balance, keeping the interest charges minimal. If you do have credit card debt, here’s how to gauge when it’s too much. 

You Have Too Much Credit Card Debt When…

There are three formulas that can help you identify when you have too much credit card debt: 

Credit utilization ratio: Total credit card balance / total credit limit

Your credit utilization, the percentage of your available credit limits that you’re actually using, has the second-biggest impact on your credit score after payment history. The lower your credit utilization ratio, the better. As a rule of thumb, a ratio greater than 30 percent will hurt your score.

Debt-to-income ratio: Total monthly debt & housing payments / total gross monthly income

This 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 reviewing new credit applications to determine how much more debt you can take on—or not. 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%.

Credit card debt ratio: Total monthly credit card payments / total monthly income

This ratio will tell you when your payments are too much for your budget, if you can’t already tell. If your minimum required payment is more than 10% of your take-home income (after taxes), paying for routine expenses and necessities can become difficult.

There are also many non-mathematical signs you may be overwhelmed with credit card debt. If even one of the following situations rings a bell, that’s a red flag:  

  • You spend more than you earn each month
  • You’re missing or making late payments on credit card accounts to afford other bills
  • You’ve used a cash advance from one credit card to pay another
  • You rely on credit cards to afford daily purchases like gas and groceries  
  • Instead of adding money to a savings account each month, you’re making credit card payments
  • You’ve considered filing for bankruptcy

How to Benefit From Credit Cards and Avoid Debt

Despite the gloom and doom described above, credit cards are a useful financial tool that can actually be rewarding and improve your credit score when used wisely. 

Follow these 10 recommendations to avoid burying yourself in credit card debt:

1. Read all the fine print: Learn as much as you can about your current credit cards and any you want to apply for. Carefully review the card issuer webpages, credit card terms and conditions and benefit guides. Knowing how and when you’ll pay will help you use credit wisely.   

2. Establish credit card “rules”: If you’re new to using credit cards, or just want to develop better habits, establish spending rules for your card(s) and stick to them. For example, only use your credit card for groceries or routine car maintenance—both expenses your budget should already support.

3. Create a budget that includes credit card spending: Credit card use must factor into your budget. Prevent credit card debt by establishing ahead of time how much you can charge each month. Make sure you base that figure on what your bank account shows you can afford. 

4. Don’t charge more than you can afford: Credit cards are not an excuse to go on a shopping spree. Live within your means and only use your card to pay for things you could also pay for with cash or your debit card. 

5. Pay your bill on time each month: If you don't pay on time, you’ll face late fees and interest charges. Depending on how late you pay, your card issuer may also raise your APR to the penalty rate outlined in your card’s terms and conditions. Penalty rates are often around 30%. If you have trouble remembering due dates, set up calendar alerts or automatic payments. Payments are due on the same day each month. 

6. Regularly check credit card accounts: 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 may help motivate you to pay off the balance quickly.

6. Don’t take out cash advances: Using a credit card for a cash advance means paying higher interest charges and transaction fees. And these transactions don’t have a grace period, which means interest is charged starting the day you take out the advance, not when the billing cycle closes.

8. Limit the number of cards in your wallet: Don’t open new cards on a whim. A wallet full of cards may encourage excess spending, and make it hard to keep track of where your money is going. Focus on using cards that work well with your existing spending habits.

9. Check your credit reports: Credit reports show the debts you owe, your repayment history, the number of inquiries on your accounts, and what types of credit you are 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

10. Ask for help if you need it: If you become overwhelmed, connect with non-profit credit counseling services that can offer advice. Reach out to the card issuers if you have questions or concerns. Don’t wait until accounts fall delinquent.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

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