The Optimal Credit Card Balance
Credit cards are an easy way to get credit but they are an even easier way to bury oneself in debt. The traps of credit cards have been extensively discussed on this site, as well as what to do when you find yourself heavy in debt. But as with many things in life, it is much better to avoid falling in the trap than to fall in the trap and think how to get out of there. It has been repeated many times, that one must spend wisely but sometimes it is not so obvious what “wisely” means.
As far as credit cards are concerned, the wisest way of spending your money is to pay back in due time your balance. Leaving a balance for the next month is the first step towards getting in debt. If you have a credit card with a long low (or zero) interest rate, it is very stupid to leave a balance at the end of the introductory period, especially if the interest rate increases significantly after that.
In a sense, the optimal credit card balance is zero. But many people can't achieve this and make huge profits for the credit card issuers by paying interest, late fees and/or over the limit fees. Or worse – people simply can't pay off their balance and slip into debt. In this case credit card issuers do not profit – on the contrary, they suffer significant losses, so it is not surprising that credit card issuers do not love customers who fail to pay back what they have borrowed.
Because of this, credit card issuers do not like people who keep high outstanding balances because such people, even if they have been brilliant payees in the past, pose a higher credit risk. Most often the amount of the outstanding balance is measured not in absolute terms (i.e. $1,000, $10,000 and so on) but in percentages of your income and of your credit limit and here more is not better.
It is widely accepted that if your outstanding balance is under 25% of your credit limit, then you are a reliable payee. Well, this does not mean that you must never use the other 75% of your credit limit. This means only that, if for example your credit limit is $2000, you mustn't leave more than $500 of it unpaid at the end of the month. You can shop as much as you like (or as much as you can afford) but pay it back before the end of the month.
Your income is another factor in measuring the optimal balance. It is believed that if your outstanding monthly payments are less than 36% of your gross income, then you are doing well and you are not a credit risk. Well, practically 36% of your income is pretty much, so after you pay the rent and all the other recurring monthly bills, you might have less than 36% of your income left for debt payment, so in this case what is optimal for a creditor is not optimal for you but if your monthly debt payments are over 25%, this must ring a bell in your head.
If you are heavily in debt, you might need some professional advice from a financial consultant in order how to get out of debt. Some of the solutions include negotiations with your creditors and rescheduling your payments. In this case, the optimal credit card balance is the one that saves you more money – i.e. you leave an outstanding balance of those credit lines that charge less interest and pay first the higher interest ones.
Also, if your annual income is unevenly distributed among the twelve months of the year – for instance your income is higher in summer because of seasonal work, you may want to leave the high balance as it is in winter and pay it in summer, when you will have more money. It depends if your creditors will accept such a schedule but in any case, unless you manage to find a zero rate credit card, it is much better to put off the payment till the moment when the pastures are greener.
With all that said, it is necessary to point out that there is no single solution of the problem. For different people the optimal credit card balance is different but the general truth is that more often than not a zero balance is best!