Credit 101: How to manage credit card debt

There are many types of debt we can take on. Some can be used as a tool. Mortgage debt, for instance, can help you buy a house that may go up in value while you own it, which is a way many Americans use debt to build wealth. 

People might also take out a loan to fund a profitable business or take on student loan debt to get a degree so they can make more money at work. Credit card debt, on the other hand, is usually expensive and hard to get out of. 

Credit cards can still be very helpful tools in your personal finance toolbox though. They can help you build your credit history and pay for big purchases and unexpected expenses. They can even give you cash-back rewards on purchases you were already going to make.

To get the most out of credit cards, you just need to get down some simple spending and debt management concepts. One of the most important questions to be able to answer is: How much credit card debt is too much for you?

There are a few different ways to answer this question. Let’s dive in and figure out what might be the answer for you. 

What is credit, and what is debt?

Credit is access to borrowed money from a lender, like a financial institution, to a borrower.  Debt is the amount of money that the borrower must pay back. Usually, the total amount of debt is the money borrowed plus the fees and interest charges for repayment. In the case of a loan (like a personal loan, student loan, or auto loan), the fees and interest are spelled out in advance. Most loans come with an agreed-upon payment schedule that includes the number of loan payments you’ll have to make and the amount of those payments. 

Credit cards are different from standard loans because they are revolving lines of credit. This means you have an amount of credit available, which you can use and pay off with some flexibility. While the fine print on your credit card agreement will give you all the information — like interest rates, late fees, and how your credit card company determines the minimum payment — the actual payment amount and interest you have to pay can change depending on how much you spent and the amount of your repayments. 

Pro tip: Many credit card issuers allow you to pay no interest at all if you don’t have a balance and pay your statement balance in full each month. As an added bonus, when you know you have to pay for a purchase in its entirety soon, you’ll be more conscious about how much money you’re spending. 

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How does credit card debt affect your credit score?

Banks and credit card companies look at your credit report to determine how likely it is that you will pay back the money you owe on time, based on what other customers have done in the past. If a person has a high credit score, lenders assume that, based on their credit history, they are likely to pay as agreed. 

Some of the metrics that improve a credit score are pretty straightforward. Having a long history of on-time payments, for example, can boost your score. Your credit score isn’t just about your payment history, though. A big part of it is not having too much credit card debt as compared to your credit limit, which is the amount of credit you’ve been granted. This is your credit utilization ratio, and it’s calculated for each card individually and for your total credit utilization as described below. 

If you want to know how much credit card debt will negatively impact your credit score, start by figuring out your credit utilization ratio. You can find it by dividing your total credit card balances by your total credit limits. For example, if you have two credit cards and Card A has a $1,000 limit and Card B has a $1,200 limit, your total credit limit is $2,200. Let’s say you have a $200 balance on Card A and a $70 balance on Card B. Your total balance is $270, so your credit utilization ratio is 270 divided by 2,200, which is equal to 13%. 

A low credit utilization ratio tells banks and credit card companies that you’re good at repaying the money that you borrow. Anything up to 10% is considered low and can boost your credit score because it signals that your finances are in excellent shape. A credit utilization ratio above 30% is considered high and can damage your credit score.  

How to figure out how much credit card debt is too much

Figuring out how much debt is too much (whether it’s credit card debt or any other type of debt) is something each person must figure out based on their own unique situation. For a person who makes $20,000 a year, the amount of debt they can comfortably manage will be less than it would be for someone who makes $200,000 a year. 

Let’s take a look at some questions you can ask yourself to figure out if taking on new debt is something you’ll be able to manage.

Can you comfortably make your existing payments?

You have to manage your cash flow to be sure you have enough money coming in to pay your monthly expenses. If you’re struggling with cash flow, that’s a major warning sign that you have too much debt. 

What’s your debt-to-income ratio?

An important metric lenders will use to determine if they want to lend someone money is their debt-to-income ratio (DTI). What is a debt-to-income ratio? It’s all your debts compared to your gross income, on a monthly basis. 

Lenders use DTI because if a person’s debt is low compared to how much money they’re making, paying back the loan should be easier. You can use this same metric to check your own credit health. 

The Consumer Financial Protection Bureau (CFPB) recommends that homeowners keep their DTI at 36% or less, while renters should aim for 15%-20% or less. Homeowners have higher DTIs because they’re making their mortgage payments. Banks and credit card companies usually want to see DTIs in these ranges because this means the borrower can probably manage their debt payments. 

To find your DTI, you need to figure out all of your minimum debt payments. This could include:

• Credit card bills (the monthly minimum payment for each) 

• Your monthly car payment

• Your monthly student loan payments

• Any other monthly loan or debt payments

Once you have that total, divide it by your gross monthly income (otherwise known as your pretax income).  

For instance, someone who makes a gross amount of $5,000 per month and who has $1,800 in total monthly debt payments would have a DTI of 36%, which might make them seem like a good candidate to a lender.

If your DTI is much higher than the CFPB’s recommended range, you may need to focus on lowering your monthly debt. 

How to handle too much credit card debt

If you find yourself with too much credit card debt, there are ways to recover. Here are some popular strategies people use to manage credit card debt:

Build a budget and start saving

It’s best to cut your spending where you can. The less you spend, the less you’ll have to repay — and you can use the extra savings to pay down what you already owe. 

A budget can help you take control of your finances and ensure that you have the money you need when you need it. 

Pro tip: Use the money you save from cutting your spending to make bigger payments to your credit card with the highest interest rate. This will lower the total amount of interest you pay each month and help a lot in paying off that debt.

Look for lower payment options.

Credit cards use daily compounding interest on your debt, so another way to get control of your debt is to find lower interest rates. Many credit card companies offer assistance to customers that can’t make payments. Remember, lenders want to be repaid. There’s no guarantee here, but sometimes all it takes is a phone call to get your interest rate lowered. 

You can also look at your cards to see if there are any zero, or low-interest, balance transfer options. Make sure you read the fine print here — high balance transfer fees are common, and sometimes an attractive rate for a balance transfer will only last a few months before a much higher rate kicks in. Make sure you’ll actually get a better deal before you transfer a balance from one credit card to another. 

Pay more than the minimum.

A good rule of thumb when it comes to credit cards with high interest rates is to make more than the minimum payments every month. Credit card companies charge compound interest on any remaining balance on your credit card each month, which means your debt keeps growing even if you’re not making any more charges on your credit card.

Unless you’re doing something like funding a business which has the potential to make more money than you pay in interest (no guarantee, though!), a good practice with credit cards is to pay the full statement balance each billing period. 

Minimize your spending, and don’t close your accounts.

You may hear advice to close credit card accounts once you pay them off. If this stops you from getting back into debt, that might be the move for you. But before you cancel your newly paid-off credit card, remember the credit utilization ratio. When you close an account, you lower your total available credit. That could hurt your credit score and send interest rates higher on the other accounts you’re still paying off. 

Instead, remove the temptation to spend on a paid-off credit card by taking it out of your wallet and disconnecting it from your digital payments. Keep it out of sight and out of reach while you pay off your other debts.

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How much credit card debt is too much? The answer depends on your personal finances, but a good rule of thumb is to make sure that you don’t take on more credit card debt than you can pay off each month. If you have too much credit card debt, it might impact your credit score because you’ll then have a higher credit utilization ratio. It could also make it difficult to make your monthly payments and avoid paying high interest on your credit card balances. 

Whatever your debt level, practice good credit card habits to improve your financial situation. Set a budget and stick to it, and only use your credit cards for purchases you can pay off in full. For bigger purchases, make sure you have a repayment plan in mind before you buy. 

Remember that managing your credit card debt is just one part of a bigger financial picture. By regularly educating yourself and making smart money decisions, you can achieve long-term financial stability and peace of mind. Visit the Greenlight blog for more money content, from student loans to emergency funds, to help you along the way.