My financial turnaround began a little over a year ago. After reading some articles online about personal finance, I was persuaded to head to the local library to pick up some personal finance books.
It was the summer before my senior year and I was having one of those, “oh my god, I’m graduating in a year moments”. Life transitioning moments like a graduation, marriage, birth of a child, or purchase of a house are usually the sparks that lite the change in many people’s personal finance lives.
In hindsight, it was one of the best decisions I’ve ever made. As soon as I was finished with the first book – it was The Automatic Millionaire by David Bach – I was hooked. I wanted to tell everyone what I had learned and have them be as interested in personal finance as I was.
The trend I began to notice in the personal finance books I was reading was that every now and then certain facts, graphs, or insight would show up that would stop me in my tracks and overhaul the way I viewed money forever.
These moments are much more much life-changing than a friend or family memeber just saying, “hey, you should pay off your credit card debt.” They are moments of clarity, of education.
Today, we’ll dive into some of these facts of clarity when looking at information on credit card debt and how much paying the minimum is really costing you every month.
The True Cost of Paying the Minimum on a Credit Card
Many people assume paying the minimum on their credit card statement isn’t hurting them too much. Most people think of a credit card balance as a temporary problem that will eventually be handled. Everyone believes they’ll pay it off someday.
Even if you do pay off your credit card balance, the cost of keeping any balance on your credit card is astronomical. Credit cards offer interest rates around 15-19% which doesn’t seem terrible upon first glance.
This graph with hypothetical data paints a different picture and shows how much paying the minimum on your credit card really costs.
Minimum Monthly Payment: 2%
|Time to Pay Off Debt||310 months or 26 years|
|Debt Actually Costs||$10,896|
Paying the minimum is easy. It seems like progress is being made, but the truth is that only the credit card company is pocketing the money. When one is carrying a balance, a huge percentage of the payment goes towards paying the interest. The principal – the money you borrowed and needs to be paid off – is take care of after the credit card company gets there loan back. In the case above, this takes decades.
For example, the first month’s payment for the $3,000 worth of debt would look like this:
Min. Payment: $60
Remaining Balance: $2,988
Total Interest Paid: $48
Only 20% of the payment is going towards the principal while a whopping 80% is going to the credit card company because they let you borrow their money.
To compare, this is what the last payment would look like:
Min. Payment: $13
Remaining Balance: $0
Total Interest Paid: $7,986
Check out creditcards.com for a more detailed graph of these numbers.
These numbers are frightening and too many people never spend the time to figure out how much it really costs to finance an item on their credit card.
Paying the minimum can eventually lead to someone paying off their entire credit card balance, but it rarely does. The reason is that credit card debt continues to grow. The above graph is only true if the person with $3,000 worth of debt stops using the card altogether. However, if the card is active, it is often being used and the balance is increasing as the payments are made.
Unless the card is frozen or cut up, paying the minimum on the card will only have the credit card company getting richer with interest payments every month for a long time.
What hurts even more is the opportunity lost while this money was being paid to the credit card company in interest. That money could have been incurring interest in a savings account or in the stock market. Here is what that $10,896 could have possibly done invested – assuming an 8% historical market average return – instead of being locked up in credit card debt.
Invested as $419 per year for 26 years
These numbers help explain why so many people struggle with their credit card debt.
The numbers are almost possible to figure out in your head, and too many people assume the credit card company is looking out for them.
If you are buried under debt, check out some a budget calculator or credit card debt calculator at creditcards.com or bankrate.com. These allow you to plug in your own numbers and figure out how long it will take to pay off your debt, and what you can do to accelerate your debt repayment.