The recent recession prompted many consumers to think differently about the ways in which they handle all aspects of their finances, and that included their credit usage. Credit card debt in particular took a huge dip in the immediate aftermath of the downturn, and still remains well below levels seen prior to the recession.
And while credit card debt has ticked upward somewhat slowly in the past year or more — largely the result of individuals feeling better about their personal financial standings — balances on these accounts actually declined for much of the summer, according to the latest data from the Federal Reserve Board, which releases national consumer credit statistics every month. In August, the most recent period for which data was available, balances dipped 1.2 percent to a nationwide total of $848.9 billion. In fact, that followed declines of 5.2 and 2.6 percent in June and July, respectively, which indicated a declining appetite for this type of debt overall.
However, it’s also important to note that consumer debt actually increased overall in August, as the amount of credit taken on for “non-revolving” balances increased some $14.5 billion, or 8 percent, overall, the report said. Much of that was due to yet another increase in student loan balances owed to the federal government, which have ballooned in the past few years alone or so to $701.3 billion, nearly double the $356.2 billion seen at the end of 2010.
The good news for consumers, though, is that reducing their credit card debt in particular may be beneficial for both their overall finances and their credit scores overall. The reasons for this are myriad.
Why it helps your finances
The problem with credit card debt, for the people who do not approach these accounts with all due caution, is that it carries over from one month to the next — and often beyond — and accrues interest charges at rates much more costly than those for other types of accounts. Interest rates on credit cards can reach as high as 20 percent or beyond, compared with those in the low- or even mid-single digits for, say, auto loans or mortgages.
For this reason, balances can grow quickly if significant steps are not taken to keep them low or even non-existent from one month to the next. Those who use their cards to make everyday purchases, rather than only swiping them sparingly throughout the month, may be most susceptible to this reality, while consumers who make sure to only spend as much on their cards every month as they can also afford to pay back will likely have the easiest time in dealing with these accounts.
If you’ve already racked up significant credit card debts and want to get out from under them in a timely fashion, making sure to stop using the cards altogether, or only in emergencies, is a vital first step. After that, you’ll need to start making larger monthly contributions into the debt; this helps because federal law requires that anything you put toward your balances that exceeds the limit listed on the bill will be applied directly to your principal, rather than any interest you’ve accrued. That, in turn, makes sure your debt and interest charges both grow more slowly in the future.
Why it helps your credit
Cutting into your debt is one of the best things you can do for your credit standings because 30 percent of those scores is made up entirely of your “credit utilization ratio.” This is an industry term for the percentage of your credit limits you’re using at any one time, and the more you owe, the lower your score will be. The only way to max out this portion of your rating is to keep your debts to less than 30 percent of your combined account maximums.
Meanwhile, significantly reduced balances also lead to far lower monthly minimums, thereby reducing your risk of not being able to afford to pay your bills when other financial difficulties arise. That can likewise be vital to a strong credit standing, because another 35 percent of your ratings is made up entirely of your payment history. Missing even one deadline can reduce your scores by 100 points or more, and thus staying current is vital. If you have made such a misstep, it will likely take you several months or more of on-time payments to get your score back to where it was before.
When you’re trying to make sure your credit scores are as good as they possibly can be, you should also be taking the time to order copies of your credit reports and check them closely for any potentially unfair markings. If you spot any such entries, you might want to contact a credit repair company about the issue, as this may get them cleared up more quickly.
