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How Much Credit Card Debt is Too Much?

Credit Card Debt

According to the 2015 Federal Reserve study, the average US household credit card debt is $15,863, based on a NerdWallet analysis. That amount seems fairly significant to some, not so surprising to others. To a creditor, that looks like a lot of profit! Your interpretation of the average level of household debt is similar to the answer to the question of credit card debt. There is a range of answers that we’ll dive into, but the simplest one is: any.

To clarify, any balance you carry into a new month where you are charged interest is too much. Think of it in the inverse: if someone offered you a 17.93% (or whatever percentage your credit card interest rate happens to be today) return on an investment each year. That would seem too good to be true – that’s the kind of return only stock market legends can make. You’re right to be skeptical because it’s a serious amount of money. Somehow with credit cards, we let the severity of that amount slide for the convenience of the card.

Some people love the thrill of playing with other people’s money. This is can be a great plan, if you play it well. For example, you could make a small renovation to your home to improve its value all completed on a 12 month 0% interest credit card. You could very well come out ahead with an improved home value and an essentially free loan if you pay the balance off within the 12-month period. If you start paying interest on the balance, your future financial gains from the home improvement could soon be lost with the cost of your credit card interest payments.

Credit Card Debt

The notion that any balance is too much credit card debt comes from the idea that you start paying for your loan. Credit cards are useful tools, but are the most expensive types of loans. Normally, credit cards provide very convenient small loans. You charge something to your credit card, and then you have a month grace period to pay it off before interest is charged. When you carry a balance on your credit card, though, this grace period can disappear. During the first month, you can have a balance for free. During the second month with a balance remaining, instead of being charged interest on your second month’s purchases at the end of the second month, you’re being charged interest on the entire balance you’re carrying. If you carry over $1 from the previous month, you may loose your grace period. This means that you pay interest on the last months and on any new charge from the moment it hits your account. And with the power of compound interest, your debt will increase exponentially. Though a small balance can be manageable, what’s small for some people could turn into debilitating debt for others. Therefore, the best guideline to follow is any debt it too much debt.

Unfortunately, many people carry a balance on their credit card. This reality is clear from the Federal Reserve statistic and is likely familiar if you’ve click on this link. So, while the above rule is an important goal, it may not always be realistic. If you are carrying a balance above zero, there are a few indicators of what is a reasonable level of credit card debt.

When it exceeds 10 to 20 % of your Take-Home Income

To provide a guideline, bankruptcy expert Elizabeth Warren provides the 50/30/20 concept. Fifty percent of your income should first be spent on essentials of housing, food, transportation and utilities. The next 20 percent goes to financial obligations of savings and debt. Thirty percent goes to your lifestyle and your ‘wants’. This general financial rule helps build a healthy budget by covering your needs, your future and your wants. By this rule, if your credit card debt is taking up more than 20% of your monthly take-home income, then it’s too much. Twenty percent is high, as it assume that you’re not saving or investing any of that amount. However, to provide a personal limit and red flag, keep 20% as your rule of thumb. A lower level and of course, zero, is the goal, but 10% being half of your allotted amount for financial obligations is a reasonable level and 20% is the high-end.

When it’s Stressful

Holding debt can be stressful. It can weigh on your mind, put pressure on your time, your finances and your relationships with your family or significant other. Beyond any numerical amount, if your credit card debt is causing you emotional stress or keeps you up at night wondering about how you’ll make your next payment, then that amount is too much.

When the Credit Card Company Passes the Buck

Be wary of debt advice provided by credit card companies. These companies make money on your debt, so they are happy for you to hold a balance, so long as you eventually pay it off, and line their pockets with interest while doing so. However, there comes a point when even they say ‘enough.’ Your card limit is a standard cap for the amount of debt you can hold. However, that is as much as you can spend. Your accumulated balance and interest can be much higher than the limit. If you continue to pay the minimum, you can continue to hold build the interest and pay it off in the long, long terms. However, if you stop making payments, after about 150 days or 6 months, the credit card company will stop trying to collect from you and sell your debt to a collection agency. At this point, it is a huge, waving red flag that your debt is too much. Thankfully, there are laws in place to protect you from the severe collections harassment, but it’s not a pleasant experience once you owe to a collections agency.

Credit card debt is different for different people. Spending levels, stress levels, and income levels all weigh into your debt and your credit strategy. A rule of thumb is any balance carried to a new month is too much. However, if you’re seeking a more-than-zero limit, consider keeping 10 to 20% of your net income as the high-end amount of your credit card debt.