Are you average when it comes to credit cards?
The U.S. Census Bureau projects that there will be 181 million credit cardholders in the United States by 2010. With our nation's growing reliance on credit, it is important to understand how credit cards can affect your financial situation.
The average American family has eight to ten credit cards with interest rates from 12-26%. Of those that carry a balance, the average is about $10,000. Furthermore, one in six families makes only the minimum payment due each month, making it nearly impossible to eliminate a large balance. Although the majority of Americans believe that debt is an unavoidable part of modern life, credit card debt and high interest fees do not have to be.
Consider this: If you had $5,000 on a card with a 15% interest rate and you were to make minimum 2.5% payments, it would take you over 20 years to pay off your debt and you would have paid about $4,760 in interest. This example illustrates why it is much more cost-effective to pay off your credit card balance each month.
In addition to causing high interest payments, a high credit card balance can hurt your credit score. Thirty percent of your FICO score reflects your credit utilization; that is, the ratio between the amount you owe and the amount of credit you have available. The closer you get to your maximum balance, the more your credit score is negatively affected. In fact, your score can go down when you owe more than just 30 percent of what is available to you. It's important to keep your balance well below the 30 percent threshold, too, because lenders can decrease your limit with little notice. For example, if you have a $10,000 limit and you're carrying a balance of $3,000, your credit utilization is 30%. However, if your credit limit is cut to $6,000, then your existing $3,000 balance creates a 50% utilization, and harms your credit score.
There are benefits to regular credit card use. Some cards offer rewards such as frequent flyer miles and cash rebates; the caution here is to be sure you are not paying more in interest and fees than you are receiving in rewards. Common types of credit card fees include application fees, annual fees, over-the-limit fees, and late fees. However, many of these charges can be avoided with a close examination of the disclosures in your credit card application and responsible credit card use. Although a high balance can harm your credit score, your credit score will improve with moderate utilization and timely monthly payments.
Don't be average when it comes to credit cards. There is no better way to perpetuate debt than to carry a credit card balance. Making only minimum payments could cost you thousands in interest fees that could otherwise be applied toward savings or entertainment. If you are carrying a credit card balance, work hard to pay it off and keep it paid off.