Roughly 70% of American households own a credit card and the average individual owes a little over $5,300 on it.

This isn't always a bad thing. In fact, when used wisely, many consumers can get enormous value out of rewards programs and credit card points. However, just as often people struggle. Credit card companies can charge interest rates of nearly 30%, and many individuals can spend years trying to pay off even a relatively minor purchase at the minimum payment rate.

The first step to understanding how to get value out of your card instead of losing your shirt? Understanding credit card balances.

What Is a Credit Card Balance?

A credit card balance is the total amount of money you currently owe to your credit card company. It does not include speculative amounts like future interest rates or anticipated spending, but does include any debts already incurred such as past purchases, late fees and any prior month's interest.

A typical credit card balance will include some or all of the following charges:

  • Any purchases made with the card,
  • Any fees assessed by the credit card company (such as use or membership fees)
  • Any penalties assessed by the credit card company (such as late fees)

The sum total of these and any other charges will make up your credit card balance.

You reduce your credit card balance every time you make a payment on the card. Your balance is considered a single amount owed to the credit card company in total. Any payments you make count against that single balance rather than against any individual charges. (That is, if you pay $500, that payment is made to the whole credit card bill, not to any specific charge or fee on it.)

The exception to this rule is in rewards points. In some instances, a credit card will have rewards programs that apply to specific categories of purchases. In this case, payments and activity might differ based on category of spending within the credit card balance. For example, on a travel rewards card, you might use points to pay for specific travel-related purchases rather than applying those points to the balance overall.

Credit Card Balance vs. Credit Limit vs. Credit Card Statement

A credit card balance is the amount you currently owe on your card and is typically updated within 24 - 72 hours of any new activity. It is as close to real-time as your credit card gets.

Credit Card Balance vs. Credit Limit

Your credit limit is how much you can owe in total on your credit card at one time. For example, if your card has a $10,000 limit, that means that you cannot spend more than $10,000 on this card without paying some of that money back.

Your current spending power, otherwise known as "available credit," is the difference between your credit card balance and your credit card limit. For example, if you have a $10,000 limit on your card and a balance of $6,000, you have $4,000 in available credit to spend.

Credit Card Balance vs. Credit Card Statement

Your credit card statement is calculated at the end of each month. It is the amount that you owe as of the end of that billing cycle. To put it another way, your credit card statement is equal to the amount of your credit card balance on the last day of each month's billing cycle.

While the statement is the amount that you owe at the end of each month, it is not the amount you have to pay. You only need to make the minimum payment (whatever that is on your particular card) in order to keep your account in good standing. However, if you do not pay back the full amount of the credit card statement at the end of the month it will roll over to the next and remain on your credit card balance.

Credit Card Balance and Interest Rates

It is always a good idea to pay off as much of your credit card as possible. In fact, if you are working to pay down debt overall, this is generally the best place to start because credit cards charge some of the highest interest of any consumer lending product.

Credit cards calculate interest in one of two ways:

Compounded Monthly

When interest is calculated monthly it means that your credit card company charges interest based on your monthly credit card statement. Whatever amount you owe on that statement is the amount that the company uses to assess interest. This means that if you pay off your credit card before the end of each month you will owe $0 in interest.

Perhaps because it allowed people to manage their finances well, this is falling out of favor among many credit card issuers.

Compounded Daily

When interest is calculated daily it means that your credit card company charges interest based on your daily credit card balance. Interest is compounded on a daily basis rather than once a month.

Under a compounded-daily scheme it is almost impossible to avoid paying at least some interest on your credit card. Typically, to calculate daily interest, when the credit card company generates your monthly statement it also calculates an average daily balance and applies a modified version of the monthly interest rate to that average daily balance. It then multiplies that result times the number of days in the statement's month.

Credit Card Balance and Credit Score

Your credit card balance is part of the formula that agencies use to calculate your credit score. This process once relied on your statement balance but computers now allow credit rating agencies to use more real-time data.

This affects your credit score in two ways: First, a higher credit card balance is generally worse for your credit score. Second, a credit card balance that uses more of your available credit is generally worse for your credit score. Together this is known as "credit utilization." A lower credit utilization is better and will help improve your credit score.

So, for example, if you have a $10,000 credit limit on your card and have a credit card balance of $5,000, you have a credit utilization of 50%. You can reduce this either by raising your credit limit or (preferably) by paying off more of your card balance.

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