Credit cards can be a powerful financial tool. When used wisely, they can help you establish a credit history and improve your credit scores. However, keeping your credit card balances in check is an important piece of the credit puzzle.
Your credit utilization ratio—also known as your debt-to-credit ratio—is an important factor used in calculating your credit scores. This ratio, which is expressed as a percentage, is the amount of your total outstanding credit card balances divided by the sum of each card’s limit. In general, borrowers with a ratio of about 30 percent or less are viewed as less-risky by lenders.
If you normally max out your credit cards or regularly rack up high balances, consider the following six tips to help keep your card balances low:
1. Understand the power of interest rates. When you use a credit card, you’re borrowing money. The fee attached to borrowing that money is the interest rate, expressed as an annual percentage rate, or APR. So when you make a purchase and don’t pay it off in full, you end up paying more than the sale price due to the interest accrued on your balance.
2. Pay off your entire balance every month. You are only charged interest if you carry a balance on your card. Instead of just making the minimum payment required, adopt a different attitude and think of each balance as a financial emergency, says Jason Hull, certified financial planner and owner of Hull Financial Planning in Fort Worth, Texas. “It’s much better to be completely debt-free than to owe your financial life to someone else,” Hull says.
3. If you do have sizeable debt, make a plan. Set a goal, such as paying off all credit card debt in one year, or whatever time frame is reasonable for the amount of debt you owe. Keep track of your spending and decide which expenses, such as cable TV or eating out, you’re willing to forego, says Khloe Karova, certified financial planner and owner of Modern Capital Concepts in Chicago.
4. Use technology to your advantage. Once your budget is solidified, consider using automatic bill pay for recurring, essential payments, and set up a monthly automatic transfer into a savings fund. Use financial management apps to track your spending and saving, and set reminders on your phone so you never miss any payments.
5. When shopping, play mind games. Leave your credit cards at home and pack a reasonable amount of cash instead. At the store, let your eyes, not your hands, do the browsing. “[If you touch things], you’ll become more emotionally attached and more likely to buy,” Hull says.
6. Resist signing up for too many store cards. Saving money on your credit card purchases by signing up for a store card might sound responsible, but may not be a good idea in the long run. Store cards are harder to monitor, Karova says, and they typically come with high interest rates.