Credit card companies don’t really want you to pay more than the minimums on your credit cards. That’s how they make all of their money. They have devised a system that will keep you a customer of theirs for your entire life--if you chose to play their game of making minimum payments. It's ingenious, actually, and quite brilliant as a business plan. But what does it mean for you? It means that you're going to be paying off those same balances well into your golden years.
Let me give you a few examples. First we’ll take a higher credit card balance of $14,000 at an interest rate of 13.75%. (This information is being taken off an existing credit card statement). The minimum monthly payment on the bill is $179; the interest accrued for the same month is $178.73. So you do the math -- .27 goes to principle that month. With an annual fee of $50, obviously this account will only go up, not down. You will literally never pay this particular credit card in full, and the bank has the pleasure of having you as a customer for life.
Let’s take another example. This card has a balance of $7,500 at an interest rate of 24.24%. The minimum payment is $159, and the interest accrued for the same month is $143.22. In this scenario, a whopping $15.78 goes to principle when you pay the minimum payment. Now I’m curious about something--if you take these two different scenarios, and the fact that the first statement’s balance is a little more than double the second, why would the minimum payments only vary by $20? The answer to that question is, “it depends.” Some banks only set the interest as the minimum (like in our first example). Some set it at interest plus 1%, while others just go by 1% to 5% of the entire balance. Not very comforting or even helpful, is it?!
In my experience I’ve often seen consumers take their monthly statements, tear off the top portion, only read the “minimum payment due,” and not even look at the interest rate or the balance on the account. In our second example above, monthly minimum payments keep you as a loyal customer for 47 years, paying an estimated total of $45,528 in interest. And that’s the good news if you never use that card again. Looks to me more like 600% interest than 24.24%, as you end up paying 6 times that original $7,500 debt. If you got that card when you were 20 years old, charged some clothes for a new job, some DVDs, bought a new computer and maybe some repairs for your car, you’ll be paying on those items your entire adult life and into retirement.
Our final example is a credit card with a balance of $1300 and an interest rate of 24.9%. This, by the way, is pretty normal for smaller balance cards. The minimum payment on this card is $41, with monthly accrued interest of $27.90. Making only minimum payments will take 13 years to pay it off at an estimated cost of $3,465. That’s almost three times more than the amount borrowed.
Let’s take a different scenario. Say you’re that 20-year old from our example above, and you want a new computer. You put money aside every week from your paycheck, and within three months you go into your local electronics store and pay cash. Buy your clothes at the outlet malls or the stores that carry department store brands at reduced prices. If you’re hooked on department stores wait for the sales, and only buy if you have the cash to pay for the clothes you want. Keep your car maintained regularly and pay cash for repairs. This is the best way to avoid those big, scary repair bills. And buy those DVDs online only when you can afford to pay cash for them. If you know where to shop, you’ll find they’re much cheaper, and you won’t even have to pay shipping. If you made these changes, you would literally save yourself $38,028 plus any late charges, over-limit charges, or the additional charges that you get hit with when your limit comes down. Pretty eye-opening, isn’t it?
The credit card companies have worked out a beautiful system where you can have everything you want today, as long as you’re willing to pay them for the rest of your life. That’s how minimum payments work. Is this how you want to live?
The Debt Lady says, “Interest is the money the bank pays YOU for your savings account!”
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Jerri Simpson, known as “The Debt Lady” (www.thedebtlady.com/), has worked in the finance industry for over 31 years, helping others conquer their financial troubles (thedebtlady.com/blog/testimonials/) and is well-known for her blogs (thedebtlady.blogspot.com/).
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