Americans have almost $1 trillion in revolving debt as of March 2017, according to the U.S. Federal Reserve. At $999.8 billion, that’s about $8,550 per household based on 2015 census data. Most of that revolving debt is held on credit cards, which is why financial experts vilify them.
It’s common knowledge that credit card debt is not the kind of debt you want to have. But it’s not always easily apparent how your credit card balance is hurting you. Here are the ways credit card debt affects you and what you can do about it.
It dings your credit
“After timely payment, the credit utilization ratio is the second highest factor in calculating your credit score,” says Wendy Moyers, a Certified Financial Planner and founder of Linden Oak Wealth Partners.
Your credit utilization ratio is calculated by dividing your balance by the card’s credit limit. For example, if you have a $500 balance on a card with a $1,000 credit limit, your credit utilization is 50%. The ideal credit utilization ratio is 30% or less on individual credit cards and across all of your cards, Moyers says.
If it’s higher than that, the FICO credit scoring algorithm tends to see it as a sign that you’re overburdened with debt and your credit score may drop. The higher your utilization, the bigger the drop.
The trick is that your credit utilization can hurt your credit even if you pay off your balance in full each month. That’s because the day your credit card company reports your balance may not be the same day you pay off your balance.
Taking the previous example, say you pay off your $500 balance on the 15th of the month, but the credit card company reports your balance on the 14th. You’ll still have a 50% credit utilization, despite having paid off the balance in full.
What you can do
Always strive to keep your credit card balance below 30% of your credit limit, even if you pay it off in full each month. If you want to play it safe, contact your credit card company and ask what day of the month they report your balance. Then be sure to make a payment before that date.
Just be aware that not using your credit card at all may not help boost your credit score. Because the credit bureaus track your balances and your payments, showing no activity at all may actually ding your score a bit. The best course of action is to use the card every month and pay off the balance in full.
If you find yourself struggling to keep the balance low, you have options. “Request an increase in your credit line, if your credit score and payment history allow,” says Moyers. If not, consider using another payment method for purchases once you’ve reached the 30% threshold.
Another option is to make multiple payments throughout the month. This pay-as-you-go strategy helps keep your balance low and keeps you on top of your spending.
It siphons off money from your cash flow
The Federal Reserve pegs the average credit card APR at 13.86% as of February 2017. So, if you’re not paying off your credit card balance in full each month, it can have a significant impact on your short- and long-term cash flow.
As interest accrues on the balance, paying just the minimum due extends your payoff period. In some cases, it could take you years to pay off a balance, even if you don’t add more to the card.
For example, say you have a $10,000 balance on a card that charges a 15% APR and has a minimum payment of $200. If you don’t put any extra toward the card, it’ll take you a little more than 6.5 years to pay off the debt. You’ll also pay $5,791 in interest over that time, or about $880 a year.
Whether you have other debt to pay off, an emergency fund to build or a vacation coming up, that $880 a year could make a big difference.
What you can do
If you’re struggling to pay off your credit card balance, consider using cash or a debit card until you can get rid of the debt. If you have good or excellent credit, shop around for a balance transfer credit card. These credit cards come with 0% APR promotions that help you avoid interest while you’re paying down the debt.
Once you’ve paid off your debt, create a budget to keep your spending in check. Also, save money into an emergency fund each month to prepare for the unexpected. This strategy can help you avoid acquiring credit card debt again in the future.
Use credit cards wisely to build credit
“Your credit is important to monitor and protect, even if you are not planning on buying a house or financing a car or using a credit card,” says Moyers. “Many other institutions use your credit … such as insurance providers, landlords if you are renting, even utility companies.”
Regardless of how you choose to use your credit cards, know that your actions can affect your credit and your future finances. Find a credit reporting company that will give you access to your credit score. Check it often to spot any issues.
If you happen to carry a balance from month to month, work to pay it off quickly. You can review credit cards that offer balance transfer promotions or go another route. The strategy isn’t as essential as the motivation, says Moyers. “The most important decision [is to] reduce your credit card as much as possible.”
Ben Luthi is a personal finance writer and a credit cards expert who loves helping consumers and business owners make better financial decisions. His work has been featured in Time, MarketWatch, Yahoo! Finance, U.S. News & World Report, CNBC, Success Magazine, USA Today, The Huffington Post and many more.