Have We Learned Our Lesson with Credit Card Debt?

Total debt increased 6% from 2013, but utilization remains low.

Are we more responsible about credit card debt?

A recent report from Equifax paints an interesting picture of the state of consumer credit card debt in the U.S. It finds that total credit card debt jumped 6 percent from $607 billion in December 2013 to $642 billion in December 2014. This seems to suggest that consumers are relying more heavily on credit cards in their financial outlook, which could be a sign of trouble.

However, the same Equifax report indicates that consumer credit utilization only increased by 1 percent over the same time. This ratio measures the amount of debt a consumer currently has versus their total available credit limit. For instance, if you have three credit cards each with a $1,000 limit and you have $500 of debt on each card, then your utilization ratio would be 50 percent.

The experts at Equifax take this as a good sign. Trey Loughran, President of Equifax Personal Information Solutions says, “During the recession many consumers felt uncertain about their financial futures. Consumers responsibly accessing credit is a positive sign for a healthy U.S. economy.”

Still, while it may be good for the economy at large, our own experts wonder if this is really a good thing for the average American consumer, in general.

“Whether you’re using all of your available credit lines or not, more debt is more debt,” says Gary Herman, President of Consolidated Credit. “Depending on how high your credit limits are, it’s entirely possible to have a low utilization ratio and still struggle to make your payments every month.”

The Catch 22 of credit utilization

In truth, a credit utilization ratio is not the most accurate measure of financial health. The ratio is most commonly used in credit score calculations. Creditors and the credit bureaus like it when you have open credit lines and maintain the debt at a reasonable level – usually less than 20-30 percent.

While this gives some indication of financial health, it’s not the most important ratio for indicating financial stability – that’s your debt-to-income ratio. This ratio measures your total monthly debt payments versus your monthly take-home income. It’s a better calculation for financial stability because it shows you have enough money to comfortably cover your debts.

The reason debt-to-income is a better measure of financial health is that it compares your total debt to income, rather than your total available credit line. That’s an important distinction and here’s why: A better credit utilization ratio doesn’t have to be achieved by reducing and managing debt effectively. If your creditors increase your credit limits, your ratio will improve without doing anything about your high debt level.

So using the example above, a 50 percent utilization ratio is high, but if your creditors all decided to increase your credit limits by $1,000 so you have a $2,000 limit on each card, then your utilization ratio drops to 25 percent. You effectively get a better utilization ratio, but you still have the same amount of debt. Essentially, you haven’t done anything right or wrong – it’s what your creditors did that fixed your ratio.

With that in mind, you can see how you can have low utilization and still struggle every month. If you are spending more than 10 percent of your take-home income on credit card debt payments, that’s usually a sign that your debt is too high. Overall, your debt-to-income ratio should be 36 percent or less, but credit card debt should only make up less than a third of that amount. It also includes things like your mortgage and auto loan.

“Low credit utilization is great for building and maintaining a better credit score,” Herman argues, “but at the end of the day, the single most important factor for credit card debt is whether or not you can make all of your payments without hurting your bottom line.”

Determining your own ratios

Checking your ratios is fairly easy to do, and it’s something you should check often if you ensure financial stability.

  • Credit utilization ratio:
    • Total credit card debt owed ÷ Total available credit limit x 100
    • Should be less than 30%
  • Credit card debt ratio:
    • Total current monthly credit card payments ÷ total take-home monthly income
    • Should be less than 10%
  • Debt-to-income ratio:
    • All monthly debt payments ÷ total take-home monthly income
    • Should be less than 36%

Of course, if you check your ratios and see your overall debt level and/or credit card debt level is too high, then you need to take steps to reduce your debt. If you can’t do that with extra cash in your budget, then you may consider options for do-it-yourself debt consolidation or if your credit score isn’t high enough to qualify for those options effectively, a debt management program may be your best option. If you’re not sure, then give us a call at to speak with a certified credit counselor about your situation.