Whether you’re new to the credit card rewards space or you’ve used millions of points and miles to travel the globe, there’s a cardinal rule that every rewards enthusiast should follow: It’s essential to pay off your entire credit card balance each month.
When you carry an outstanding credit card balance from one month to the next, it doesn’t take long for the interest charges you pay to wipe out the value of any rewards you might earn.
Thanks to rising interest rates, carrying credit card debt is more expensive than it was in past. The average annual percentage rate on a credit card was more than 20% for interest-assessing accounts at the end of 2022, according to the Federal Reserve. Additionally, some cardholders pay higher-than-average interest rates, depending on their creditworthiness and the type of account they open.
High-interest charges are the most obvious way credit card debt could cost you money. However, there are less apparent ways that poor credit card management habits could come back to haunt your wallet as well.
Here’s what you need to know, along with tips on keeping your credit and money safe.
Credit card debt and your credit score
Credit utilization — the percentage of available credit you’re using on a credit card account — is a major factor that contributes to 30% of your FICO score. Therefore, the credit card debt you carry (or the lack thereof) can heavily influence your credit score.
Some financial experts recommend keeping your utilization rate below 30% to avoid credit problems. Yet, in reality, even lower credit utilization is better than that. There’s no such thing as a “perfect” credit utilization rate. However, FICO research shows that consumers with the highest credit scores use 7% of their credit card limits, on average.
No matter how much you charge on your credit card account during the month, paying your bill on time and in full every month is important. Paying off your full credit card balance is TPG’s top credit card commandment. If you don’t follow these rules and let the balances and utilization rates on your credit cards increase, your credit score may decline.
Related: How long can negative information hurt your credit score?
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The cost of a lower credit score
Lenders, credit card companies, and many other businesses rely on credit scores to predict risk. In general, consumers with the highest credit scores have access to the lowest interest rates on loans, credit cards and other financing products. Good credit could even help you save money on things like auto insurance and apartment lease deposits.
If you carry debt on your credit card accounts and a higher utilization rate triggers a drop in your credit score, you could face expensive financial consequences in the future. Below are two examples of how a lower credit score (from a higher credit card utilization rate or credit report factors) might cost you.
Buying a house
If you use your credit cards wisely, they can help you build credit and perhaps put you in a better position when you’re preparing to buy a house. But if you run up a large amount of credit card debt, those same accounts could damage your credit score and make it more difficult to qualify for an affordable home loan.
Below is an estimate that shows how much extra you might have to pay on a $400,000 mortgage over 30 years if you have a 620 FICO score versus a 720 FICO score, according to the myFICO Loan Savings Calculator:
| FICO® score | 620. | 720. |
|---|---|---|
| APR | 7.833% | 6.466% |
| Monthly payment | $2,889. | $2,519. |
| Total interest | $639,905. | $506,960. |
In this example, having a higher credit score could save you:
- $370 per month.
- $4,440 per year.
- $132,945 over the life of the loan.
Related: Why paying off credit card balances is more important than ever
Financing a car
Let’s consider another situation where having a lower credit score could cost you money: financing a vehicle. Again, if you revolve outstanding balances on your credit cards, there’s a good chance you will damage your credit score. If your credit score is lower because you’re in credit card debt, it can cost you extra money when you need to borrow money.
Here’s an estimate that demonstrates how much more it might cost you to take out a $30,000 auto loan over five years with that same 620 vs. 720 credit score, according to the myFICO Loan Savings Calculator:
| FICO® score | 620. | 720. |
|---|---|---|
| APR | 11.716% | 6.722% |
| Monthly payment | $663. | $590. |
| Total interest | $9,782. | $5,407. |
Based on the example above, the lower credit score would cost you an additional:
- $73 per month.
- $876 per year.
- $4,375 over the life of the loan.
Related: 8 basic financial services and credit card concepts you should know
Tips for paying down your credit card debt
There’s no question that carrying credit card debt can be expensive — both in obvious and less obvious ways. So, if you’re struggling with credit card balances that you can’t afford to pay off all at once, it’s important to create a plan to start dealing with your debt sooner rather than later.
Create a budget
Unless you’re bouncing back from a short-term financial disaster, the source of credit card debt might have to do with your budget. No matter how much or how little income you earn, if you spend more money than you make, it’s easy to create a debt problem.
A budget can help you map out your financial goals and priorities. It can also help you create a plan to use your credit cards responsibly and manage your spending on multiple accounts. These steps can help you enjoy the benefits your credit cards offer without wasting money on interest and potentially damaging your credit score.
Related: Staying organized: The best apps for money management
Make a debt elimination plan
Once you have a budget to track your spending, it’s important to create a plan to pay down your existing credit card debt. Here are two popular strategies:
- Debt snowball method: List out your credit card debt from the lowest balance to the highest. From there, apply all the extra funds available in your budget toward the account with the lowest balance and repeat until you eliminate all your debt.
- Debt avalanche method: List your credit card debt in order of the interest rates you’re paying, from highest to lowest. All extra cash should go toward paying off the credit card with the highest interest rate. Once that account has a zero balance, move on to the credit card with the next highest APR and repeat until you pay off all your debt.
The debt snowball method could lower your credit utilization rates faster, saving you money in the long run. The debt avalanche method eliminates your current high-interest debts first, resulting in more immediate savings.
Consider debt consolidation
For many people, paying down credit card debt takes time. If your credit is in decent shape, you might consider consolidating your debt to potentially speed up your debt elimination efforts.
Two popular ways to consolidate debt are balance transfer credit cards and personal loans. If you can qualify for a lower interest rate, either option might save you money. Remember, it’s essential to avoid overspending in the future for this method to help rather than hurt you in the long run.
Bottom line
Carrying credit card debt can negatively affect credit scores, leading to higher interest rates on loans and credit cards. High-interest charges can wipe out the value of any rewards earned.
To deal with credit card debt, create a budget, consider debt consolidation and prioritize paying off high-interest debt.