Get Out of Debt

How Much Is Too Much Credit Card Debt? And What to Do About It

Are you beginning to get uneasy about the rising balance on your credit card accounts? Maybe you are wondering how your credit card balances affect your credit score or puzzling over how you are going to pay your minimum payments each month. Or perhaps you are just curious about how much credit card debt is too much.

How much credit card debt is okay?

According to the Federal Reserve, revolving credit in the U.S. was at $960.8 billion in June 2016. If you divide that figure by America’s 122 million households (source), that means that the average U.S. household owes $7,875 in credit card debt. Is that amount of credit card debt okay?

Although having some credit card is not the end of the word, you should avoid carrying any balance, certainly anything more than a few hundred dollars. After all, our goal is to save and invest money, not pay interest on everyday purchases.

If you can pay off your entire balance every month, using your credit cards causes no financial harm. On the contrary, you can earn miles, points, cash back and other goodies. When you begin to carry a balance, however, you have to pay interest on your balance each month until the balance is paid in full. This means you end up paying more for whatever you purchased with your credit card than you would have paid if you’d used cash.

But when does credit card debt become a problem? That varies from person to person and is largely dependent upon your ability to pay your credit card accounts without financial hardship.

Here are some signs you are carrying too much credit card debt.

You have too much credit card debt if you:

  • Are only paying the minimum payment due every month.
  • Sometimes miss payments because you can’t afford them.
  • Max out your credit cards.
  • Pay credit card bills with other credit cards.
  • Feel hopeless about ever paying off your credit card debt.
  • Have been charged a penalty for late payments or have been notified by your credit card company of a change in your interest rate due to late payments (i.e. penalty rate).
  • Receive a credit-limit reduction without requesting one.

How does credit card debt affect your credit score?

Everybody needs a basic understanding of what a credit score is and how it is determined. Your credit score is the three-digit number, ranging from 300 to 850, that lenders use in tandem with your credit report to decide whether or not to approve you for a loan or credit. Lenders also use your credit score to help set terms such as your interest rate and your credit limit.

Three common and well-known credit scores on the market are VantageScore, PLUS score, and FICO score. FICO is the credit score lenders most commonly use.
Your FICO credit score is affected by factors such as:

  • The number of accounts you have
  • The types of credit accounts you own
  • Your credit to debt ratio
  • The length of your credit history
  • Your payment history
  • Credit inquiries

Credit cards affect your credit score in several ways. For instance, late payments to credit card companies will lower your credit score because your payment history accounts for approximately 35 percent of your FICO score.

If you have several credit cards or credit card accounts which have been recently opened (as in the case of card accounts you open to take advantage of a 0-percent interest rate on balance transfers), your credit score may also take a little ding.

What is your credit to debt ratio and why does it matter?

Your credit to debt ratio is also called your open credit card utilization percentage. This percentage represents how much of your available credit card limits you are using at a given time. It can be calculated by taking your total credit card balances and dividing that number by your total limits.

You credit to debt ratio will determine 30 percent of your FICO score. When you are carrying large balances on your credit cards, your open credit card utilization percentage makes your credit score drop. The higher the ratio, the lower your credit score will be.

Why does your credit to debt ratio matter? Lenders believe that if you max out your credit cards each month, you are at higher risk of being unable to repay your debt than if you use your cards more sparingly. Keeping your utilization percentage under 30 percent of your total credit limit is a good way to prevent your credit score from dropping.

What strategies can you use to pay off credit card debt?

If your credit card debt is too high, there are several things you can do to dig yourself back out of your financial hole and pay off your credit card debt. The first thing you can do is to work out a budget that eliminates future credit card spending. Resolving to quit using your credit cards will help you get back on firmer financial ground more quickly.

Here are a few more strategies to help:

Use some of your savings

If you have access to a savings account, you might decide it is worthwhile to pay a lump-sum payment on one or more of your credit cards to jump start your journey toward financial freedom. After all, you are probably paying much more in credit card interest than the paltry rates savings accounts yield nowadays.

Request an interest rate decrease

If your credit score is excellent, your credit card companies may agree to offer you a lower interest rate on your existing cards. While this does not always work, it is at least worth a phone call to ask.

Make more than the minimum payment each month

If you make only the minimum payment each month, you will likely spend years paying off your balances. For instance, let’s say that you owe $15,000, and your credit card has an average interest rate of 15 percent. Credit card companies usually calculate minimum payments as interest plus 1 percent (up to 5 percent) of the debt balance. Using this scenario, a $15,000 debt would take over 33 years to repay if you only made minimum payments. That would amount to a whopping $18, 230 in interest payments over 33 years. If you think about the actual cost of interest on your credit card balance, you are more likely to pay your credit card debt sooner. If possible, try to at least double your monthly payment.

Transfer balances to low-interest rate cards

If you have several cards, transfer balances from higher interest rate cards to lower interest rate cards. Then, make payments for as much as you can afford on the cards that are left.

Create a snowball effect

Many people find it helpful to concentrate on paying off one card at a time. To do this, pick the card with the lowest balance and pay it completely off while paying the minimum amount due on all your other cards. Once that card is paid off, apply the money you were paying for it to the next card on your list, and so on until all your cards are paid in full.

Trigger an avalanche

Another option is to choose the card with the highest interest rate and concentrate on paying it off first. Then, follow through as you would with the snowball effect until all your cards are paid.

When should you consider debt settlement?

Though the strategies mentioned above can work, there are times when you need to get a little more aggressive. When your debt load becomes unmanageable, it may be time to think about debt settlement solutions.

What does it mean to have unmanageable debt?

If you find yourself unable to make minimum payments or find yourself only paying interest on your credit cards and never reducing the principal balance due, your debt has become unmanageable.

Debt settlement is the process of negotiating with creditors to reduce your debt balance. Debt settlement companies can reduce debt by as much as 50 percent because professional negotiators work on behalf of consumers to negotiate with their lenders. The strategy typically lowers a consumer’s monthly payment substantially. Debt settlement programs typically last between 24-48 months.

While entering a debt settlement program will have a short-term negative effect on your credit score, debt settlement helps you avoid the negative impact of a bankruptcy proceeding while still reducing the amount you owe to credit card companies by a substantial amount.

Debt settlement companies negotiate directly with your creditors to reduce your debt in exchange for a lump-sum payment. These companies do not charge any fees until they settle an account.