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If you're new to the world of credit cards, you're probably looking at welcome offers and hoping for a high number: a large sign-up bonus that can reward you with tens of thousands of points.
In order to make that high number pay off, though, you need to keep another number very low — that number is your credit card balance.
What is a credit card balance?
Your credit card balance reflects how much money you owe your bank at any given time for all the transactions that have posted to your account. Each time you swipe, insert, or tap your credit card, your bank approves it, and the amount is tacked on to your balance.
At the end of each billing cycle, your bank tallies up all you owe. Then, the bank sends you a statement balance with a full rundown of all the charges it has fronted for you. Based on the amount you owe, the bank will ask you to make a minimum payment. It's often a tiny fraction of the total statement balance.
If you make the minimum payment, the rest of the money simply rolls over to a new billing cycle, but it doesn't stay the same; it gets even bigger. Even if you don't make another transaction, your bank charges interest to your credit card balance.
So here's the simple rule for your credit card balance: Keep it as close to zero as possible. By paying the full amount each month by your due date, your credit card's APR won't matter, and you won't wind up paying finance charges.
What your credit card balance does to your credit score
Your balance will do more than impact how much you pay your bank for using your credit card. It can also play a role in how much you pay for other financial products, like a mortgage or a car loan. That's because your credit card balance is a key factor in determining your credit utilization ratio, which is an important component of your overall credit score. The lower your balance, the better your credit utilization ratio.
Let's say you have a credit card with a credit limit of $10,000, and right now, you have a balance of $1,000. Your credit utilization ratio is 10 percent. That's good – most experts say you want to keep that ratio under 30 percent.
Now, let's say you have a balance of $5,000 on the same card. Your credit utilization ratio leaps to 50 percent. If you decide to apply for a loan to buy a condo, that big balance and less-than-stellar ratio is going to raise some eyebrows at the bank that is deciding whether to let you borrow the cash.
Your application could be denied, or you could wind up paying a higher interest rate for the mortgage. Why? Because carrying too much on your credit card makes you look like you could struggle to pay all your bills. You look like a greater risk of default.
You can transfer your balance to a new card, but it's not free
If you wind up carrying a credit card balance, you might be tempted to transfer that balance to a new credit card that offers an introductory APR of 0%.
That rationale makes sense: If you don't have to pay interest, you can focus on getting rid of your balance. However, it's important to note that most cards charge a percentage fee on the balance.
For example, you might want to transfer a balance of $5,000. Before you do, make sure you read the fine print of the new card to get a complete understanding of what that will cost. It's likely the new card will charge you between 3% and 5% of the amount. So, a 5% fee on a $5,000 transfer would mean an additional $250. If you're paying an APR of 15% on your existing card, though, that transfer fee can be well worth it.
Keep a close eye on your credit card balance. If it starts to increase into uncomfortably high territory, it's time for you to take a closer look at your spending habits to avoid falling in to a debt trap.
Disclosure: This post is brought to you by the Personal Finance Insider team. We occasionally highlight financial products and services that can help you make smarter decisions with your money. We do not give investment advice or encourage you to adopt a certain investment strategy. If you take action based on one of our recommendations, we get a small share of the revenue from our commerce partners. This does not influence whether we feature a financial product or service. We operate independently from our advertising sales team.
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Please note: While the offers mentioned above are accurate at the time of publication, they're subject to change at any time and may have changed, or may no longer be available.
Disclosure: This post is brought to you by the Personal Finance Insider team. We occasionally highlight financial products and services that can help you make smarter decisions with your money. We do not give investment advice or encourage you to adopt a certain investment strategy. What you decide to do with your money is up to you. If you take action based on one of our recommendations, we get a small share of the revenue from our commerce partners. This does not influence whether we feature a financial product or service. We operate independently from our advertising sales team.