Written by: Andrew Allen
Edited by: Austin Lang
Reviewed by: Jon McDonald
When I first learned about money — dollars and coins, at least — I was intrigued that I could exchange something so inconsequential for toys. But sometimes, I’d see adults purchase something without using any currency at all. They’d simply present a small card, the cashier would fiddle with it for a minute, and the adult would walk away with goods in hand, having not spent a dime, or so it seemed.
When we become adults, much of that mystery disappears. We learn that those little cards used for transactions are credit cards, and they don’t allow us to avoid paying for things forever. They just delay the payment.
A balance is the amount of money a borrower owes a lender or creditor, and it can go up or down over time — depending on the type of financing you have.
Your balance can increase or decrease over the life of your loan or credit product, but it won’t go away until you pay it off. Managing your balances can help you avoid fees, such as interest, and should be a part of your overall financial strategy.
Your balance can also affect your credit score, which influences your chances of securing future credit products at favorable terms. Let’s dissect the role balances play in your personal finances.
How Loan Balances Work
People often use loans to finance large purchases like houses and cars since credit cards have limits and often higher interest rates. Loan balances indicate how much you owe on a loan but have a few key differences from credit card balances.
Principal and Interest in Loan Balances
Loan balances consist of two main parts: the amount borrowed, known as the principal, and interest, the charge for borrowing the principal. Depending on the type of loan, its balance can also include fees lenders charge.
For example, mortgages may roll other amounts into a loan’s balance, including payments for taxes and insurance.
The Benefits of Amortization
Loans can last a long time. It’s not unusual for a mortgage to extend for 30 years.
An amortization schedule allows borrowers to see the breakdown of interest and principal for each upcoming payment, as well as the remaining balance after future payments.
Making extra payments to your loan permanently alters your amortization schedule, allowing you to pay off your loan faster. The more extra payments you make, the shorter your amortization schedule gets — as long as those payments are put toward the principal, not interest.
Impact of Late Payments
Lenders may charge late fees when borrowers make late payments on a loan, which adds to the overall cost. Missing payments can also result in increased interest charges and can damage your credit score if a lender reports to credit bureaus.
Loans are tough enough to pay off without adding more fees. Pay close attention to payment due dates to avoid increasing your loan’s overall balance.
Balances on Credit Cards
A credit card can be a powerful instrument in anyone’s financial toolkit. But with great power comes great responsibility.
How you handle credit plays a big role in shaping your financial picture, so you should make a habit of tracking your credit card balances to keep your finances in shape.
How Credit Cards Calculate Balances
The balance on your credit card statement may not simply be a sum of the purchases you made since your last billing period. Credit card balances can include interest charges applied to amounts not paid by their due date.
Balances may also include fees for owning the card, late payments, or other special financing options you used the card for, including balance transfers and cash advances.
Making payments to your card account reduces its balance. Even when you can’t pay a balance in full, you can submit a partial payment to potentially sidestep fees and lower your credit utilization ratio.
If you can pay your balance in full before your due date, you could take advantage of your card’s grace period, which is the period of time between the statement and the due date when you aren’t charged interest. Most credit cards have a grace period, but you must pay off your entire balance to keep it.
The Role of Credit Limits
Credit card issuers set limits on how much a borrower can spend with their cards. That’s a good thing because it protects borrowers from making purchases they may not be able to repay. It’s also why you don’t see the parking lots of freshmen dormitories filled with Bugattis and Lambos.
When your card balances grow, your available credit shrinks. Hopefully, you’re not getting tired of easy math because here’s more: Your available credit equals your credit limit minus your balance.
Minimum Payments and Credit Balances
In a perfect world, we’d all pay our card balances in full each month. But even a cursory look at news headlines usually reveals the imperfections of life on Earth.
You can make a minimum payment to your card issuer to reduce a balance, but unpaid balances accrue interest. Card issuers indicate the amount of the minimum payment they require on your statement.
Interest grows on your unpaid balances according to the rate your issuer charges. If you make only the minimum payment, which rarely covers your entire balance or the purchases you make on the card each month, the rest of your balance is subject to interest.
And since some issuers charge relatively high rates, unpaid balances can quickly soar. Check your credit card agreement to learn how your issuer calculates interest on unpaid balances.
Other Account Balances
You’ve probably seen a statue of Lady Justice at some point in your life. With origins in Roman mythology, she’s usually depicted wearing a blindfold and holding balanced scales in her hands.
No, Lady Justice wasn’t a contestant in a cooking contest that forced her to measure ingredients without using her eyes — her appearance is meant to convey the ideas of impartiality and equality in justice.
You can think of the balances on credit and deposit products as two sides of a scale. Of course, your credit and deposit balances won’t usually be equal, but they are two important figures in your overall financial management. Credit balances represent amounts you owe to lenders, and deposit balances are funds you own.
Checking Account Balances
Checking account balances reflect how much money you have in your account at a given point in time. The figure includes any deposits you’ve made or directed, as well as any withdrawals you’ve taken from the account.
Monitor your checking account balance to be sure you have enough money in it to cover any immediate, upcoming expenses. Most institutions will charge you a fee, known as an overdraft or non-sufficient funds fee when your account balance drops below zero.
One or two overdraft fees won’t totally upend your personal finances, but banks can charge in excess of $30 each time your balance drops below zero.
Overdraft fees can quickly pile up to reach hundreds or thousands of dollars in a relatively small window of time, so be diligent and use the resources available to you to keep your balance positive.
You can also opt out of overdraft coverage, which means no overdraft fees, but your transactions will be declined.
Savings Account Balances
Savings account balances, like checking balances, represent how much money you have in your account. You might cringe when you open up your credit card statement and see a balance that’s much higher than you expected. But that frown will turn upside down when your savings account statement reveals a bigger balance than you’d anticipated.
Depository institutions offer interest on account balances to those who’ve entrusted their money to savings products. Larger balances lead to greater returns, so consider keeping your savings balances high to ramp up savings balances.
Savings accounts function differently than checking accounts. While you can use your checking account to execute a variety of transactions, many banks and credit unions limit how much you can transact from a savings account.
The Federal Reserve once limited accountholders to six transactions per month from their savings accounts. They’ve since removed that restriction, but many financial institutions still impose transaction limits on savings accounts. Your bank may charge you a fee if you make too many transactions, including withdrawals, from your savings account within a month.
Charging a fee for transactions may sound egregious, but you can use it to your advantage. Let an excessive transaction charge motivate you to refrain from dipping into your savings. Use your checking account as an operational account to pay your bills, and, if necessary, transfer funds from your savings to your checking to cover unforeseen expenses and avoid overdraft fees.
Prepaid Debit Card Balances
Prepaid debit cards can be a great tool for consumers who don’t have access to banks or credit unions. When you open a prepaid debit card, your balance is the amount you load onto the card. As you use the card to make purchases, your balance diminishes.
If you try to spend more than your card’s remaining balance, your transaction will most likely be declined. That means you won’t be able to complete the purchase you wanted to, but you’ll also avoid those pesky overdraft fees.
You may be able to load additional funds onto your prepaid card. Check with your card’s issuer prior to opening the card to understand whether they allow you to load more funds and any fees they assess for doing so.
Any fees charged by your prepaid debit card issuer will be deducted from the card’s balance.
How Balances Can Impact Credit Scores
A football game’s action occurs on the field, but fans still glance at the scoreboard throughout contests for a snapshot of how their team is doing. Similarly, your credit score indicates your performance when it comes to managing credit.
Credit scores don’t tell your whole credit story, but they allow lenders to quickly gauge your creditworthiness. Since solid credit scores open the doors to more credit products at better terms, it’s in your best interest to boost your score. And balances can impact your credit score.
Your Credit Utilization Ratio
Straightforward concepts can have intimidating names. I remember walking into a math class one day and grumbling when I saw the words “Pythagorean Theorem” written across the chalkboard.
My dismay was fueled by my assumption that the chalkboards were soon to be filled with countless numbers and symbols resembling a scene out of “Good Will Hunting.” And maybe there’d be a reference or two to pythons tossed in the mix just to make it all worse. But the theorem ended up being pretty easy to understand.
Credit utilization ratios are like that. You can calculate your credit utilization ratio by dividing the total balances of your credit accounts by their total credit limits.
Here’s an example of how to calculate CUR for someone who has three credit cards and a $10,000 overall credit limit:
| Card A | Card B | Card C | Overall | |
|---|---|---|---|---|
| Balance | $500 | $0 | $2,150 | $2,650 |
| Credit Limit | $2,000 | $3,000 | $5,000 | $10,000 |
| Utilization Ratio | 25% | 0% | 43% | 26.50% |
Credit utilization is a big factor in your credit score because lenders view it as a signal of how responsibly you manage credit. Higher ratios can damage your score, and lower ratios can help it.
Most experts suggest keeping your credit utilization ratio under 30%, so monitor your balances in relation to your credit limits to ensure they stay under that threshold.
Carrying a Balance vs. Paying in Full
The U.S. is a free country, but that doesn’t mean its citizens don’t have the responsibility to adhere to the country’s laws. Along those lines, credit products grant us the freedom to buy something today and pay for it later. But you shouldn’t view a credit card or loan as a license to unlimited spending.
When you carry balances from one month to the next, it can negatively affect your credit utilization ratio. As noted, a higher credit utilization ratio can harm your credit score.
The higher your outstanding balances grow, the higher your credit utilization figure will be, assuming your credit limits remain the same.
Conversely, if you’re looking to boost your score, and, let’s be honest, many of us stand to benefit from an increase in our scores, pay your balances in full each month. When you do, your credit utilization ratio becomes zero.
I don’t know about you, but my favorite type of division problems are the ones that ask you to start with zero and divide it by anything else. It’s like I can almost sense the answer before I even know what the divisor is (insert a winking emoji here).
How High Balances Affect Creditworthiness
Lenders provide an invaluable service to both consumers and businesses. Think of your favorite coffee shop. Odds are the shop wouldn’t exist, or at least it wouldn’t be the same, if its owner didn’t take advantage of credit products when establishing and maintaining their business.
But lenders aren’t in business just to satisfy our cravings for caffeine and pastries. They need to earn a profit to sustain their operations. When deciding whether to lend to an individual or company, a creditor will examine a potential borrower’s creditworthiness.
If you carry high balances relative to your credit limits, the lender may perceive you as a risky borrower who won’t be able to pay back a loan. In that instance, a creditor may decline your application or offer you credit at much less favorable terms.
Lenders typically charge higher rates to less creditworthy customers to compensate them for the risk of a borrower making late payments or missing them altogether.
How to Manage Your Balances
Too much work can cause exhaustion, but too much play can leave us short on funds. Life’s all about balance.
By managing your credit balances, you can stay within your budget and avoid unnecessary expenses.
Paying More than the Minimum
People who pay more than the minimum due on a credit product can lower their balances and avoid interest fees. Though paying more than the minimum costs more upfront, you’ll be glad you did when you have extra cash on hand in the future.
Making extra payments in between regularly scheduled ones can also help you manage your balances.
Dealing With Multiple Credit Accounts
Plate spinners impress audiences with how they’re able to keep many plates spinning at once. The more plates they spin, the more it seems inevitable that at least one will fall.
It’s not so hard to manage one credit account. But managing multiple credit products takes careful planning.
Creating (and sticking to) a budget can help you stay on top of your balances and better manage loans and credit cards.
You can also use automatic payments and reminders to avoid missing payments and sinking into debt.
Consolidation or Refinancing to Lower Balances
Consolidation can help simplify your finances. Consolidating debt can involve a loan that pays off the existing debt, leaving you with one balance to manage. Some consolidation loans even offer lower rates and more favorable terms.
Balance transfer credit cards are another way to consolidate your debt. They may offer low or 0% APR promotional periods that allow you to transfer your higher-interest debt and pay less interest. But be sure to pay off your debt before the promotional period ends, or you’ll be on the hook for the remaining balance at the regular APR, which will be much higher.
Another sound strategy can be refinancing loans when you can access better rates or terms. Refinancing can lead to lower loan balances and monthly payments, allowing you to save more.
A Balance Tells How Much You Owe on a Financial Product
Mastering your personal finances is a journey aided by knowledge and planning. Part of that journey is understanding credit balances and what affects them.
Diligently managing your balances may not impress your friends or put you behind the wheel of a Mercedes Benz, but it will definitely get you far in your financial life.
