Credit Card Debt
Credit card debt is money a company owes for purchases made by credit card. It appears under liabilities on the balance sheet.
Credit card debt is a current liability, which means businesses must pay it within a normal operating cycle, (typically less than 12 months).
While they tend to have high interest rates, credit cards are a convenient source of short-term credit because they allow businesses to make small purchases right away. Interest charges accrue monthly and payment of that interest is mandatory.
Discipline is key to managing credit card debt successfully. The ideal approach is to cover the full amount each month to avoid accruing interest. If a balance builds on a company credit card, the business can use its cash flow to make a lump sum payment at its discretion.
Credit card debt is unsecured, which means payment terms are short. If a company fails to pay according to the terms of its credit card agreement, the card supplier may demand full repayment at a high rate of interest.
Credit card debt is a type of unsecured liability that is incurred through revolving credit card loans. Borrowers can accumulate credit card debt by opening numerous credit card accounts with varying terms and credit limits. All of a borrower’s credit card accounts will be reported and tracked by credit bureaus. The majority of outstanding debt on a borrower’s credit report is typically credit card debt, since these accounts are revolving and remain open indefinitely.
KEY TAKEAWAYS
- While useful for making purchases over time, credit card debt does carry some of the industry’s highest interest rates.
- Credit card debt typically accounts for a significant portion of credit utilization on a borrower’s credit profile.
- Paying down substantial portions of outstanding credit card debt is one of the best ways to rapidly improve your credit score.
Understanding Credit Card Debt
Generally, credit card debt refers to the accumulated outstanding balances that many borrowers carry over from month to month. Credit card debt can be useful for borrowers seeking to make purchases with deferred payments over time. This type of debt does carry some of the industry’s highest interest rates. However, credit card borrowers do have the option to pay off their balances each month to save on interest over the long term.
Benefits of Credit Card Debt
Credit cards are one of the most popular forms of revolving credit and offer numerous benefits for borrowers. Credit cards are issued with revolving credit limits that borrowers can utilize as needed. Payments are typically much lower than a standard non-revolving loan. Users also have the option to pay off balances to avoid high-interest costs. Additionally, most credit cards come with reward incentives such as cash back or points that can be used toward future purchases or even to pay down outstanding balances.
Credit Bureau Reporting and Analysis: What to Know
Lenders report credit card debt level balances to credit bureaus each month along with a borrower’s relevant credit activity. Thus, credit cards can be an excellent way for borrowers to build out a favorable credit profile over time. However, negative activity such as delinquent payments, high balances, and a high number of hard inquiries in a short period of time can also lead to problems for credit card borrowers.
Credit card debt is highly influential in determining a borrower’s credit score since it will typically account for a significant portion of credit utilization on a borrower’s credit profile. Credit bureaus track each individual credit account by itemized trade lines on a credit report. The aggregation of outstanding credit card debt from these trade lines is the borrower’s total credit card debt, which is used by credit bureaus to calculate their credit utilization ratio by dividing it by the aggregate amount of credit limits of all credit cards owned by the borrower. Credit card utilization is an essential component of a borrower’s credit score.
Credit card debt is a major factor in determining a borrower’s credit score
Lenders will also report a borrower’s payment activity to credit bureaus each month. Delinquent payments detract from a borrower’s credit score while on-time payments help their credit score. Maintaining on-time payments helps a borrower to achieve a higher credit score and qualify for better lending terms.
Since credit card utilization is also a factor in a borrower’s credit score, paying down substantial portions of outstanding credit card debt is one of the best ways a borrower can rapidly improve their credit score. Keeping credit card balances low will also help a borrower to maintain a good credit score.
How to pay off credit card debt
If you have credit card debt, you’re not alone. Here are the best ways to pay off credit card debt so you can be on your way to a debt-free life.
If you have credit card debt, you’re not alone. In fact, about 61% of Americans have a credit card and cardholders carry an average balance of $6,194, according to Experian. While it can be worthwhile to have a card that gives you the opportunity to earn a lot of rewards, all of those savings are for nothing if you’re carrying a balance and paying high interest.
There are plenty of ways for you to pay off credit card debt, but not all are created equal. If you want to tackle your debt head on, you’ll need to consider interest rates, fees, how much you can afford to pay and more before settling on the best repayment method.
Below, we will review the best ways to pay off credit card debt so you can be on your way to a debt-free life:
- Use a balance transfer credit card
- Consolidate debt with a personal loan
- Borrow money from family
- Pay off high-interest debt first
- Pay off the smallest balance first
Use a balance transfer credit card
One smart way to get out of debt is to complete a balance transfer. You can transfer debt from high interest credit card(s) to a balance transfer credit card that offers no interest for almost two years.
Balance transfer cards often have set maximum limits on the amount of debt you can transfer, and you can’t complete a transfer between cards issued from the same bank. Make sure you read the fine print before requesting a transfer. Also be aware that good or excellent credit is often required for a balance transfer credit card.
Consolidate debt with a personal loan
Personal loans can be a good alternative to balance transfers if you have a large amount of debt. If your debt is spread out across several credit cards, you can consolidate it into a personal loan. And depending on your credit score, you may qualify for a loan amount that will cover your entire balance.
A personal loan provides you with a fixed amount of money over a fixed time period and usually at a fixed interest rate. The interest rates for personal loans are rarely 0%, but often lower than keeping a balance on your current credit card(s).
Borrow money from family or friends
If your credit is poor (scores below 580), you may have a hard time qualifying for a balance transfer credit card or personal loan. As an alternative, you can ask a family member or close friend for a loan.
Make sure you set up a repayment plan before borrowing any money and stick to it so you don’t risk damaging your relationship.
Pay off high-interest debt first
If you have debt across multiple credit cards, it’s generally a good idea to start paying off the card with the highest interest rate first. This is called the avalanche method of debt repayment. You can minimize the interest you accrue this way, which will help you save money in the long run.
If you completed a balance transfer, but weren’t able to transfer all your debt to the intro 0% APR card, pay off any lingering balances on the high interest card first — but still make sure to pay the minimum on your balance transfer card. After the high interest balance is paid off, you can start to tackle the debt on your balance transfer card more aggressively.
Similarly, if you’ve consolidated debt with a personal loan or loan from family or friends, prioritize paying off high interest balances first. For example, say you have two credit cards, each with a $1,000 balance, but one card has a 25% APR and the other a 15% APR. After you pay the minimums each month, you should put the money from the loan toward the balance on the card with the 25% APR first. Then any remaining funds from the loan can go toward the lower APR balance.
Pay off the smallest balance first
An alternative to the avalanche method is the snowball method of debt repayment: Paying off the smallest balance first can be a good way to boost your confidence and kick off debt repayment. Let’s say you have a $5,000 balance on one card and a $1,000 balance on another. If you start paying off the $5,000 balance first, it may seem like you’re barely making a dent in your overall $6,000 debt.
But if you pay off the $1,000 balance first, you’ll be able to see your progress sooner and feel more confident about your ability to pay off credit card debt.
Financial advisors usually don’t recommend the snowball method, because it can sometimes result in more interest charges compared to if you paid off high-interest debt first. But at the end of the day, the most important thing is to create a debt repayment plan you can stick to.