You probably don’t need us to tell you this, but credit card debt happens when you make purchases using your credit card and don’t pay off the entire balance by the due date. While credit cards offer convenience and potential rewards, failing to manage them properly can lead to accumulating debt that may become difficult to control.
When you use a credit card, you're essentially taking out a loan from the credit card company. Each purchase adds to your balance, and if you don't pay the balance in full by the due date, interest charges start accruing. As this debt grows, it can lead to significant financial consequences, such as damage to your credit score and increasing interest payments.
Understanding how credit card debt works is essential to avoiding its pitfalls. Below, you'll find a complete overview of credit card debt, with insights from loan and finance experts.
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How does credit card debt work?
“Credit card debt is a form of liability or money borrowed that consumers take out from a given financial institution or bank,” says Adem Selita, CEO and co-founder of The Debt Relief Co.
It arises when cardholders carry a balance on their account beyond the grace period (the time during which no interest is charged if the balance is paid in full).
When you make a purchase using a credit card, the card issuer pays the merchant on your behalf, and you agree to repay the issuer. If you only pay the minimum amount due each month, the remaining balance rolls over to the next billing cycle, accruing interest along the way. The longer you carry a balance, the more interest you'll pay, which can quickly add up.
Most credit cards offer revolving credit, allowing you to continue borrowing up to a certain limit, provided you make the minimum payment each month. However, any unpaid balance from month to month will continue to accrue interest, often at a high rate.
The Annual Percentage Rate (APR) is the interest rate applied to any unpaid balance. If you have a high APR and continue to make only the minimum payments until your debt is paid off, you could end up paying more money in interest than the original amount you borrowed.
This is why credit card debt can grow rapidly if not managed carefully.
Key terms for understanding credit card debt
If you're not familiar with some key terms used to define credit card debt, here's a breakdown:
- Sanctioned limit: Every credit card has a sanctioned limit—which is the highest amount you can charge, depending on your credit profile, income, and debt-repaying capacity. ”You can only use the credit card for transactions up to the sanctioned limit,” says Bill Ryze, a certified Chartered Financial Consultant (ChFC) and a board advisor at Fiona.com.
- Billing cycle: Credit cards have a unique billing cycle every month. “Say your cycle starts on the 5th of the month; the bill covers all transactions made using the credit card from the 5th of the previous month to the 4th of the current billing month,” Ryze says.
- Grace period: This is the time during which your billing cycle has closed, and the time your payment is due. You typically have a grace period of approximately 15 days to pay the bill.
- Minimum amount due: “You are expected to clear the entire outstanding amount before the due date mentioned in the bill,” Ryze says. Alternatively, you can pay the “minimum amount due,” usually 5% of the outstanding bill amount. It is the minimum amount you must pay to keep your credit card open and active.
- Interest-free period: If you pay the outstanding balance on or before the due date, all the transactions made during the month are interest-free. Thus, these transactions are known as interest-free debt.
- Interest rate: “Your credit card interest starts ticking over if you fail to clear the outstanding balance before the due date,” Ryze says. “So, every transaction or part thereof that has not been repaid attracts interest at the contracted rate, which is usually around 3% per month.”
Credit card debt examples
Suppose you charge the following transactions from the 5th of June 2024 to the 4th of July 2024.
- $1000 on June 8th
- $500 on June 15th
- $1500 on June 21st
- $500 on June 28th
- $1000 on July 3rd
Since your billing date is July 5, the total debt is $4500. If you pay the entire amount before the due date on July 20, you won’t be charged any interest on the credit card debt.
Alternatively, you pay an amount, say $500, before the due date. In that case, you now have a credit card debt of $4000 with an interest rate of 3% per month. The interest starts accruing from the date of each transaction and is calculated and added to your debt in the next monthly bill.
Now comes the most important part of credit card debt: Every subsequent transaction attracts interest since you have not paid the entire outstanding. Therefore, all transactions made after July 5th, 2024, also attract interest at 3% per month. This debt keeps accumulating until you clear off the entire outstanding, which can add up to a substantial amount.
Potential consequences of credit card debt
One of the biggest downsides of credit card debt is how quickly it can spiral out of control due to compounding interest. Even a small balance can grow significantly over time if it's not paid off.
“Credit cards could lead down a slippery slope to credit card debt if you’re not wise about how you use them,” Selita says. Furthermore, you may end up paying more for your credit card purchase even if you do pay your balance in time: “Many retailers now charge a percentage to accept credit card payments so it costs more than using cash.”
What happens if you don't pay credit card debt? Here are some consequences:
- High interest costs: Most credit cards charge high annual interest rates, sometimes exceeding 20%. The longer you take to pay off your balance, the more you'll pay in interest. This refers to the Annual Percentage Rate (APR), which is the total interest charged over the course of a year. If your credit card has an APR of, say, 24%, the interest is typically compounded monthly, meaning you would be charged a fraction of that annual rate each month (in this example, the monthly interest will be 2% ).
- Damage to your credit score: Carrying a high balance or missing payments can negatively impact your credit score, making it harder to qualify for loans or get favorable interest rates in the future.
- Stress and financial strain: It can be emotionally stressful and a burden to your budget if you're struggling to make payments or falling behind.
In extreme cases, your account could be sent to a collection agency or you could be sued for unpaid debts.
How do people get into credit card debt? 4 common reasons
What puts you in credit card debt? There are many possible reasons.
- Using credit cards to fund a lifestyle beyond your means—one that you can't afford—is one of the quickest ways to rack up debt.
- Unexpected expenses, like medical emergencies, car repairs, or job loss can force people to rely on credit cards for necessities.
- Only paying the minimum amount due can make it seem like you're staying on top of your payments, but it is a trap because it often results in long-term debt with high-interest charges.
- Credit cards make it easy to buy now and pay later, which can lead to impulse purchases you might not otherwise make.
5 tips to avoid credit card debt
The key question is: How to avoid credit card debt? Here are some helpful strategies.
1. Create a budget
Tracking your spending and setting a realistic budget is the foundation of financial stability. It helps you understand where your money goes, allowing you to control your expenses and avoid overspending.
A clear budget prevents you from using credit cards to cover unnecessary purchases and keeps you from exceeding your means.
Categorize your expenses (housing, food, transportation, entertainment, etc.) and compare them to your income. Adjust spending where necessary, ensuring that your essential expenses are covered first.
“If you’re going through hard times and finding it harder to make ends meet, you might want to consider being more frugal and buying only what you need to get by week by week or month by month,” Selita says.
2. Pay your balance in full
Carrying a balance from month to month leads to interest charges that can accumulate quickly. By paying off your balance in full each billing cycle, you avoid these charges and prevent debt from growing.
This approach ensures you’re only paying for what you actually purchased—not paying extra in the form of interest.
Set up reminders or automatic payments to ensure you pay off your entire balance before the due date. Treat your credit card like a debit card and only spend what you know you can pay off at the end of the month.
3. Limit credit card use
It’s easy to overspend when using credit cards, especially with rewards programs or deferred payments. “Be careful with your spending; people tend to spend more when using a credit card than when spending cash,” Selita says.
To avoid accumulating unnecessary debt, limit your credit card use and resist the temptation to rely on it for everyday expenses. Instead, designate your credit card for specific purchases, such as travel or emergencies.
4. Build an emergency fund
Unexpected expenses, such as medical bills or car repairs, can often lead to credit card debt. Having an emergency fund gives you a financial cushion to rely on, allowing you to handle these surprises without reaching for your credit card.
Aim to save three to six months’ worth of living expenses in an easily accessible savings account. Start small and contribute consistently, even if it’s just a little from each paycheck, until you build up your fund.
5. Use cash or debit
Paying with cash or a debit card keeps you in control of your spending because you can only spend what you have. It also encourages more mindful spending since you’re not deferring payment to a later date.
Withdraw a set amount of cash for discretionary spending each week, or use your debit card for purchases where you would otherwise use a credit card. “Spending and breaking a $100 bill has a much larger psychological impact than swiping a credit card,” Selita says. “After you break that $100 you feel the impact to your wallet, but the same is not true with a credit card!”
With discipline and strategic planning, credit cards can be a useful tool rather than a source of stress.
How to pay off credit card debt
If you've already accumulated credit card debt, don't panic—there are effective ways to pay it off:
- Pay more than the minimum: This is the best way to pay off credit card debt faster!
- Use the avalanche method: Pay off high-interest cards first, then move on to lower-interest cards. (For more advice on how to manage multiple credit cards, read this: Which Credit Card Should I Pay Off First?)
- Use balance transfer offers: If you have good credit, consider doing this to a card with a lower interest rate.
- Try the snowball method: If the avalanche method is not your style, try paying off the smallest balance accounts one by one while sustaining minimum payments to all required credit cards.
“So if you have three credit cards with balances of $1,000, $2,000 and $3,000, you will first pay down the $1,000 account, then the $2,000 account and lastly the $3,000 account,” Selita says. “This method is good because it helps give you a sense of accomplishment after each account is paid off and also helps eliminate monthly payments altogether.”
“Once you go from having three minimum payments to two minimum payments you'll feel highly motivated to continue paying down your debt as aggressively as possible,” he says.“ This method has the best psychological impact on paying down debt!”
- Consolidate your debt: Pay off your credit card debt with a personal loan or debt consolidation loan at a lower interest rate.
- Seek help from a credit counselor: Nonprofit credit counseling agencies can help you create a plan to manage your debt.
Now that you know how to get out of credit card debt, hopefully you’ll never pay interest charges again!
FAQs
How much credit card debt is normal?
The amount of credit card debt considered “normal” varies depending on several factors, including your location, income, and spending habits. What's most important is how well you manage your credit card debt, regardless of how much you owe.
A “normal” amount of debt can become problematic if you're only making minimum payments, paying high interest, or using credit to cover basic living expenses. Ideally, you should aim to keep your balance low relative to your credit limit (below 30% of your credit limit) to maintain a healthy credit score and financial well-being.
What is the difference between credit card balance and debt?
Your credit card balance is the current amount you owe on your card at any given time, including purchases, interest, and fees. Credit card debt refers to any balance that carries over from month to month and accrues interest.
Is credit card debt the same as a loan?
Credit card debt is a form of unsecured loan because you borrow money without putting up collateral. However, unlike traditional loans, credit card debt is revolving, meaning you can continue borrowing as long as you don’t exceed your credit limit.
How do I know if I have credit card debt?
If you carry a balance from one billing cycle to the next and are charged interest, you have credit card debt. You can check your credit card statement to see if you have any unpaid balance or interest charges.
Can I negotiate with credit card companies to lower my interest rate?
Yes, it's possible to negotiate with your credit card issuer for a lower interest rate, especially if you have a good payment history or credit score.
What happens to credit card debt when you die?
When someone passes away, their credit card debt doesn’t simply disappear. Instead, it becomes part of the deceased’s estate, which is the total value of their assets, including property, savings, and other belongings. It doesn’t transfer to family members unless specific conditions apply.