How do I use gift card balance and not the credit card on file?

It'll be used automatically when allowed; gifts, purchases from other Family Sharing group members, and disaster relief contributions can't be paid for with store credit. If an item gets charged to the credit card when it shouldn't be, click here and contact the iTunes Store staff.

(188953)

The credit card on file will also be used when the credit balance isn't enough to cover the full amount of the purchase, such as after local sales tax has been added in the final steps of the sale.

I believe that in-app purchases can't be paid for with store credit.

M1 Mac mini, macOS 11.1; Watch, series 5 GPS/cellular, watchOS 7.2; iPad Pro 2nd Gen, iPadOS 14.3; iPad Air 2, iPadOS 14.3; iPhone 12 Pro, iOS 14.3; TV 4th Gen, tvOS 14.3  HomePods, audioOS 14.3 and Airport Express w/ Airplay 2

They can. Click here and see the entry in the top left.

(188955)

Then is that a new change? It wasn't possible in the past.