Credit cards can be both a blessing and a curse; it all depends on how you use them. On one hand, they’re great for making large purchases, and building a credit score for yourself and are even great for when you need a little extra help until your next paycheque. But it’s when you start to completely rely on them that they can wreak havoc on your finances.
Spending on credit can be convenient and can even help you build good credit, but how much is too much credit card debt?
Key Takeaways About Credit Card Debt In Canada
| Average Credit Card Debt In Canada | The average amount of credit card debt among Canadians is just over $4,300. |
| How Much Is Too Much Debt? | Whether you have too much credit card debt depends on your debt-to-income ratio and credit utilization. |
| How To Deal With Credit Card Debt? | If you’re struggling with too much credit card debt, consider measures such as slashing spending, making more than the minimum payment, and transferring your debt to a balance transfer credit card, among others. |
How Much Credit Card Debt is Normal?
As with any financial instrument, credit cards serve a purpose. When used responsibly, they can be an indispensable tool to help you access credit conveniently and quickly. However, problems arise when you rely on credit cards to cover most of your purchases, especially over a short time period.
There is no specific amount of credit card debt that would be considered “normal”. Instead, an appropriate level should be based on your income and how much you can comfortably manage without it negatively affecting your finances or credit health.
Income Level
With a higher income, you’ll be better able to manage higher credit card balances. This is especially true for credit card debt, which tends to come with higher interest rates compared to other loan types.
Generally speaking, your credit card debt will start to affect your ability to get approved for loans when your debt-to-income ratio reaches 44%. This is calculated by dividing your monthly debt to your monthly income.
Credit Utilization Ratio
Too much credit card debt can also be measured by your credit utilization ratio. It’s recommended that you should not use any more than 30% of your available credit to keep your credit score in good standing. So, if your credit card limit is $10,000, for instance, then your credit card balance should not exceed $3,000.
What Is the Average Amount Of Credit Card Debt In Canada?
The average credit card debt in Canada is currently more than $4,300. That level is rising and is the highest it’s been since 2007.
How To Tell If You Have Too Much Credit Card Debt
Here are some red flags that indicate you may have taken on too much credit card debt:
You’re Uncomfortable With The Amount Of Debt You Have
If you avert your eyes every time you open your latest credit card statement, you’ve probably accumulated too much debt. Being comfortable from a financial perspective means you’re confident in your ability to pay your bills, cover unexpected expenses, and contribute to a savings account, all while paying off any credit card debt. If you’re finding yourself constantly stressed out over your credit card bills, it may be time to take steps to cut down on this debt.
You Can’t Make Your Full Monthly Payment Every Month
If you find that you’re only making minimum payments every month, odds are your credit card balance is too high for you to manage. While making minimum payments by the due date will help you avoid late payments, it does little to help you repay what you owe, and can cause your credit card debt to continue to climb.
Your Credit Utilization Ratio Is Too High
This ratio shows the amount of debt you have outstanding relative to your credit limit. If it’s too high, your credit score will be affected negatively.
A good rule of thumb is to keep your credit utilization below 30%. If your ratio is far above this threshold, your credit card debt is likely too high.
Your Debt-To-income Ratio Is Too High
Your debt-to-income ratio shows the amount of debt you have outstanding relative to your gross monthly income. Lenders widely use this metric to assess whether to approve you for a loan. You should aim to keep this ratio below 44%.
If you calculate your ratio to be higher than 44%, you may want to revisit your credit card balances to see if this is the culprit.
You’re Relying On Your Credit Card For Essentials
Using your credit card regularly for essential expenses, like groceries or gas, may be an indication that your monthly cash flow is insufficient. This could lead to a steady accumulation of debt and interest charges.
A Large Portion Of Your Payments Goes Towards Interest
If a large percentage of your payments goes toward covering interest charges instead of principal, you may be making little progress paying down what you owe. The larger your balance, the more you’ll pay in interest, which can be significant given the relatively high interest rates that come with credit cards.
You’re Being Rejected For New Credit
If you’ve tried unsuccessfully to apply for a new credit card because your other ones are maxed out, it may be time to focus on paying down your credit card debt.
Be Wary Of The Minimum Payment Trap
One of the most common ways you can let your credit card debt get out of control is to rely on minimum payments. Most credit cards require you to make a minimum payment each month on your outstanding balance. The minimum payment is usually a percentage of your balance, but it can also be a fixed amount.
Though it’s wise to pay off your credit card balance in full each month, many people opt to pay only the minimum amount. Because there are no immediate consequences for paying only the minimum, people are easily tempted to defer payment into the future. Some people only contribute the minimum payment because they lack money for various reasons or are preoccupied with paying for other expenses.
Don’t Forget About Compound Interest
Making only the minimum payment on your credit card balance can quickly lead to serious debt problems. The danger comes with compound interest.
In the case of credit card debt, compound interest is the interest that is calculated based on the amount you borrowed plus the accumulated interest from previous periods. To put it another way, you’re being charged interest on any interest charges you don’t pay off.
Credit cards are notorious for their interest charges, which are compounded daily. The interest can be misleading, as your credit card balance appears small and insignificant in the beginning. However, over time, the outstanding balance grows exponentially until you find yourself unable to manage the payments.
How To Get Out Of Credit Card Debt
There are a variety of ways to get yourself out of credit card debt. The ideal plan will depend on the severity of your situation.
Create A Budget
Creating a realistic and effective budget is a great way to bring down your credit card debt. With a budget, you can track your expenses for a few months to become familiar with your spending habits and see where you can cut back so that you can pay more than the minimum on your credit card balance. You can utilize a spreadsheet or budgeting app to help manage your expenses.
Pay More Than The Minimum Amount
As mentioned, getting sucked into the minimum payment trap will never get you out of credit card debt. If possible, see where you can scale back on certain expenditures and dedicate that money to paying down your credit card balance.
Negotiate A Lower Rate
Contact your creditors to see if you can negotiate a lower interest rate. Sometimes reaching out and being candid about your financial situation can work in your favour, resulting in a much more manageable debt repayment plan. That said, this may only be an option if your account is in good standing.
Credit Card Balance Transfer
This technique allows you to transfer your existing credit card balance onto a new credit card that offers a promotion for a low or 0% interest rate for a specific time. Once the promotional period ends, the default rate kicks in. Ensure you pay off the entire transferred balance before the promotional period on your balance transfer credit card ends.
Debt Consolidation Loan
Debt consolidation is where you obtain a loan to pay off your existing debt, including credit cards. In doing so, you’re merging all your current eligible debt into one combined loan.
If done correctly, the payments on a debt consolidation loan should be more manageable for you to service than if you had multiple loans. You can also save money on interest if you manage to get an interest rate on your new loan that’s lower than your highest-interest debt.
Consumer Proposal
A consumer proposal is a debt relief program filed with a Licensed Insolvency Trustee (LIT) to settle debt. Under this program, you’ll be able to negotiate your debt payments to pay less than you currently owe. Keep in mind that a negative remark will remain on your credit report for a few years, during which time your credit score will take a hit.
Bankruptcy
Filing for bankruptcy is the last resort and should only be utilized if there’s no possibility of you paying your debt. Going through bankruptcy will eliminate your credit card debt, giving you a fresh start to rebuild your credit. Typically, bankruptcy is removed from your credit report after 6 or 7 years. But until then, your credit score will be significantly impacted.
How To Prevent Credit Card Debt
While there are ways to overcome credit card debt problems, taking steps to avoid them in the first place is far more manageable. Here are some tips to reduce the risk of falling into a credit card debt trap:
Build An Emergency Fund
Set aside a sum of money each month for unforeseen expenses so that you don’t have to depend on your credit card to pay for them. You can even use this financial cushion to fully cover a credit card payment in the future if money is tight.
Don’t Rely On Your Minimum Payment
Again, do your best to pay off as much of your credit card debt as possible during each month. Doing so will limit the amount of interest that accrues on your balance.
Don’t Take Cash Advances
You should avoid cash advances, as they are expensive transactions. They come with high interest rates and fees, and there’s no grace period, which means interest begins to accrue from the day you withdraw the cash.
Limit Your Available Credit
If you have a tendency max out your credit cards, perhaps reducing your available credit could help. This could prevent you from amassing too much debt on your card. Just keep in mind that lowering your credit limit could negatively impact your credit utilization ratio.
Limit The Number Of Credit Cards You Have
The fewer credit cards you have at your disposal, the less debt you can accumulate. Ideally, you should only have one credit card in your possession. If possible, consider paying in cash for as much as you can.
Final Thoughts
If you’ve found yourself with mounting credit card debt, it’s time to take immediate steps to rectify the situation. Cut your spending, make more than the minimum payments every month, and consider a balance transfer card to alleviate yourself of high interest for a few months while you work to pay down your debt.
