What Is A Credit Card Balance and Should You Carry One?
Posted on December 4, 2020 in Credit Cards
Credit cards can feel like an endless trap of growing charges and payments intended to keep you paying over time. While there is some truth to this idea, credit cards remain a great tool to help you along your path of financial independence.
The Risks Of Credit Cards
While credit cards could be a great tool for building trust with lenders, they tend to come with their own set of risks and cautions to be aware of. Understanding the risks will allow you to compare the worth of utilizing your credit cards.
Credit Card Balance
The amount of money owed to an investor for your credit card at any given time is known as your credit card balance. Different than a negative bank balance, this would be the amount you would have to pay, to get your cards to zero.
When looking at your card’s statement, you’ll also see the term statement balance. While these are similar, it’s important to know that a statement balance shows your card balance at the end of the last billing cycle. If your bill is due on the 15th of each month, most likely, the end of your previous billing cycle was on the 1st depending on how much time your bank gives you to make your payment.
While having too much debt can negatively affect your wallet with high monthly interest payments, it could also have a negative effect on your future purchases by bringing down your credit score due to high credit balances.
When looking toward your credit card payment, you have two primary focuses; principal and interest. Principal refers to the amount that you have borrowed, while interest is the charges you pay to the bank for having outstanding debt to them. Interest is often written in APR, or annual percentage rating. This is how much you will pay through the year.
Of course, you make your payments monthly and how much you’ve borrowed may change throughout the year. To calculate your monthly interest payments, take your APR divided by 12. This will tell you what percent you will pay. Now take your current balance multiplied by this number, this is how much of your bill is paid directly to the bank.
For example, if you had a credit card with 23% annual percentage rating, what would you pay per month?
0.23 APR / 12 months = 0.019, or 1.9% per month
You will pay 1.9% of your total borrowed amount in interest every month. If you had a credit card with a balance of $4,500, you would pay $85.50 ($4500 * .019) to the bank as sort of a fee you get charged for owing money, and the rest of your payment would go to the principal.
Growing interest payments have become the issues with many cardholders, with many monthly minimum payments covering just a little more than the interest payment. When holding multiple cards as most people do, these minimum payments can add up to hundreds of dollars spent every month on interest alone. At the end of the month you could expect almost no reduction in how much you owe, even with hundreds of dollars spent toward your credit card accounts.
False Financial Stability
Credit cards give you a false feeling of financial stability. When your funds begin to diminish, a normal reaction would be a change in lifestyle to catch yourself before you blow all your cash and have nothing left. Having a credit card gives you that feeling of “if I run too low, I can just charge it,” often causing people to overlook overspending.
This becomes a deeper issue when overlooking set payments such as auto loans.
Understanding your finances allows you to make moves towards improving your overall life. It’s hard to determine when is the right time to fix up the house, or buy a new car, or even buy yourself something special without understanding if and when you are financially stable.
Difficulty Tracking Spending
Tracking actual spending can become an issue with credit cards, especially when the card is through a secondary bank. Unlike your bank account which drops to zero, your credit account rises over time until it reaches its max. Unless you took note of your month’s beginning balance, or went back through and calculated it manually, you won’t know how much you have spent this month, and how far outside of your budget you have gone.
Utilization can be overlooked easily, especially since most cardholders have multiple cards. Overusing your credit cards can have a negative effect on your credit score, and should be avoided.
At first glance, your credit score appears to be a complex mess of random things that come up to a magic number. Understanding your credit score will help you make sound decisions towards raising your actual score value, and set you up for future success.
While we would like to believe cash is king, your credit score is the primary focus for lenders as they consider giving you a large loan for a house, car, or anything really. Think of your credit score like your financial report card.
Your score is displayed as a number between 300 and 850, and is ultimately an example of how risky it would be for a lender to hand you their money. A score of 800 or above is considered excellent, 740 to 799 is very good, 670 to 739 is good, 580 to 669 is fair, and 300 to 579 is considered poor. It’s encouraged for many loans to have a score above a 650, and U.S. adults on average have a score around 695.
There are three credit bureaus in the United States, including Equifax, Experian, and TransUnion, who collect public and private information on most citizens from their lenders, thus creating your credit score. This is information such as how often you ask for money, are you paying that money back, and how much of your available credit you’re taking advantage of.
Your scores may differ between each bureau as they have access to various information. Your report is then collected by a variety of scoring companies who attempt to make sense of all this information, such as FICO.
How Credit Cards Affect Credit Score
A major factor when looking at a credit score is payment history, or more importantly, how many times you have missed paying back your debts. Credit bureaus look at a variety of different debts, such as major loans like auto and home, recurring bills such as utilities and phone bills, and revolving debts such as credit cards.
Credit cards act as a great example for the bureau to see that you’re acting responsibly with your loaned funds. These payments are typically made every month, allowing them to assess if they are made on time, and they can see how rapidly your debt rises and falls over time.
When considering how much of your available debt you are using, you will find the term credit utilization. This is one of the largest factors lenders view when considering loaning you funds.
Credit utilization is the amount you have available, compared to the amount you are using. If they allow you to borrow up to $6,000 with a credit card, and you use $2,300, you are utilizing 38%.
$2300 use / $6000 limit = .38333 or 38% utilization
Ultimately, you have a cap on how much debt is reasonable compared to your income. If you make $40,000 a year, a loan for a $900,000 house is, well, excessive. Your income simply couldn’t cover the monthly payments.
Once a lender allows you to borrow a certain amount of money, they watch to see if you are using the funds reasonably. If you cards stay maxed out, it could be a sign that you are using more than you make, or that you simply don’t prioritize paying the money back to the bank.
Let’s think about this in a simpler form. A friend asks to borrow $20, and says he’ll pay you back. The next month you ask about it and he gives you $0.50, and the following month you ask again and he gives you $0.25. Over time, he may just tell you to wait, or that he doesn’t have it. One day he asks to borrow $1,000 — do you let him? You gave him a chance with the $20 and it was so hard to get even that back.
This is how a lender looks at you. They will allow you to borrow a smaller amount with a credit card to see how things go, then when you ask about buying a new car or a house they can determine how responsible you were before.
Should You Carry A Balance?
A good credit utilization is below 30%, as this shows you’re using the funds responsibly and are able to pay them back. At the same time, 0% utilization can be looked at poorly, as lenders are unable to evaluate that you’re being responsible with funds.
Your best option is to maintain a credit utilization between 1 and 10%, giving you up to 20% as a safety net, and above that for emergencies.
The Takeaway: Your credit card balance can tell lenders a lot about you, so while carrying a balance can help you build your credit, aim for only about 1 to 10% utilization if you can.
It’s important to understand your financial situation on your path to becoming debt free and financially stable. Becoming more educated through the knowledge within Turbo Finance can place you on the road to financial freedom.
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