What’s even worse than the short-term embarrassment of having your credit card declined at the cash register? The long-term impact it can have on your financial health and borrowing power.
If you often lean on your credit card to cover your total at checkout, it could be easy to overlook exactly how much you’re spending with each transaction and how it’s inflating your balance. Over time, you could end up blowing through your entire credit limit, which is bad news for your credit score.
Where credit card debt stands today
Credit card balances vary across states, age groups, and even genders. However, the average American’s credit card balance stood at $5,589 in 2022, according to the most recent data from Experian. Those balances are also subject to record-high interest rates. The most recent data from the Federal Reserve showed that average credit card interest rates hit an all-time high of 20.40%. Some retail cards even hit interest rates as high as 30% in the past year.
Federal funds rate increases in the past year have played a major role in rising credit card interest rates. During times of high inflation, the Fed may raise its target rate to increase the cost of borrowing and slow consumer demand. Doing so influences the prime rate, which credit card issuers use as a basis for determining credit card APRs.
The result: a perfect storm that can make it difficult to eliminate your credit card debt now and keep your balance low in the future.
Maxing out your credit card can significantly impact your score
Maxing out your card limit reduces how much credit you have available should you want to finance a larger purchase or cover an emergency expense. But it can also negatively impact your FICO credit score. This is a three-digit number that ranges from 300 to 850 and is used by lenders to determine how likely you are to pay back a loan. For consumers, a good credit score is key to borrowing money at an affordable rate.
View this interactive chart on Fortune.com
When it comes to maintaining good credit, you should focus on behaviors such as paying your bills on time, keep your balances low, and being mindful of credit inquiries, according to Heather Philp, senior vice president of credit card products for Wells Fargo. "So if we think about what happens when you max out your credit card, that has about a 30% impact on your score," she says.
Philp adds that most experts suggest keeping your credit utilization—the size of your balance on your cards versus your total available credit—at 30% or less. In fact, the lower your balance, the better it is for your score. Even so, she recognizes that financial emergencies happen. If you don’t have an emergency fund to serve as a financial lifeboat, you may consider using your credit card to cover an unexpected expense. In this case, Philp says it’s best to keep that spending to a minimum.
Tips for maintaining a low credit card balance
While you usually can't predict a financial emergency, there are steps you can take to keep your credit card balance low and avoid hurting your credit score.
- Set up balance alerts: Your bank may already have safeguards in place that are meant to help you avoid racking up extra debt. See if you have the option of setting up alerts that notify you if your balance reaches a certain amount. “Most people are usually just spending, and it's not until a month or two later that they realize that their credit score has been impacted because they were so close to their [limit],” says Philp. “Setting up that balance alert really helps in terms of keeping you in control of your finances.”
- Create an emergency fund: Another tried-and-true method for keeping your credit card balance low: Have a financial safety net in place so you don't have to rely on credit in the event of an emergency. Less than half of Americans have enough savings to cover a $1,000 emergency, according to a Bankrate survey. About 35% of respondents also said they would cover an emergency by using a credit card or a personal loan, or borrowing money from family and friends. So aim to keep at least three to six months worth of living expenses in your emergency fund. This figure may vary depending on your unique financial situation, but even a small emergency fund can help limit how much you put on a credit card if the unexpected happens.
- Don’t spend more than you can afford to pay off: If you use your credit card frequently, aim to only make purchases that you can afford to pay off when your bill is due and avoid carrying a balance month over month. Your payment history and total balance account for the bulk of your score, so making on-time payments and keeping your spending to a minimum will ensure that your balance remains low.
- Consider asking for a credit limit increase: Depending on your credit history and card issuer, you may qualify for a credit limit increase. Credit card issuers will sometimes increase your credit limit automatically, but you can also request it yourself. Keep in mind that if you have a hard time spending in moderation, this may not be the move for you. But if you can practice self-control and maintain a monthly budget, a higher credit limit can increase your available credit and reduce your overall credit utilization.
The takeaway
When managed responsibly, credit cards can make it easier to afford more expensive purchases. However, if your balance gets out of hand, your credit card could become your worst enemy. By closely monitoring your balance and being diligent about making on-time payments, you can keep your credit card debt at a minimum.
