Convenience and a chance to afford bigger items that you might not be able to pay for in full with cash are provided by credit cards. They could also be a means for you to start and maintain a good credit history. When interest and fees are taken into account, it’s critical to comprehend the full cost of credit cards. If using credit implies paying more over time for goods after interest is taken into account, it might not be as handy. Here is an example of how the true cost of credit may mount up.
Paying Only the Minimum Due
Making the error of merely paying the minimal amount owing on your credit card payment is a common one. When you merely make the minimum payment, your balance is reduced more slowly. In the interim, interest is progressively added to the amount you owe. Your minimum payment might not even be sufficient to pay the interest for the month if the interest rate is too high.
Consider charging a $2,500 television to a credit card with an 18% annual percentage rate (APR). Your minimum monthly payment could be as low as $50, but you must understand how it is computed in order to determine your overall long-term expenses.
Calculation of Minimum Payments
The standard method for calculating a minimal payment is to use a percentage of your total balance. Depending on the card, the percentage amount is typically around 2% but can change. Remember that the minimum payment covers both the interest due and the initial balance. The initial sum in this instance was $2,500.
2% of the original debt for the $2,500 television would be $50. Your payment would pay for $38 in interest and $12 toward your $2,500 obligation at an APR of 18%. You would still be in debt after the first payment of $2,4878. The fundamental formula is:
18% divided by 360 days in a year yields.05%.
Add.05% to the number of calendar days, which equals 1.5%.
Finally, multiply 1.5% by the $2,500 starting balance to get the interest amount of $37.50 (rounded to the next dollar).
What Is the Real Cost of Credit Cards?
It would take 333 months to pay off your debt if you made only 2% of the total amount due each month. In other words, it would take nearly 28 years to pay off a liability of $2,500. Long before you paid off the television, it most likely wouldn’t have worked anymore.
Even if you opted to pay over 28 years, you would still have had to pay interest of $5,896.48. Your actual out-of-pocket expense for the television would be $8,396.48.
The danger of the minimum-payment trap is more obvious when you consider the true cost of credit in such setting. You can be putting yourself in a long-term debt for goods that won’t last. By paying interest fees concurrently, you may potentially triple the cost of the purchase—or, in the case of the TV, double it.
Using Interest to Your Advantage
There is another way to see interest, and that is as a tool for enhancing your financial growth. Consider the potential earnings if you had invested the $50 for 28 years in a savings account. It would have been a sizable sum even at the low interest rates in effect right now.
Consider opening a brokerage account with a 5% interest rate and depositing $50 each month for 28 years. Let’s also factor in the amount of taxes that, assuming a 25% tax rate on the money earned, you would have had to pay.
Your whole financial gain was $36,034. You would have received interest income of $19,184. Your total tax obligation (at a rate of 25%) on the interest would have been $4,796. You would have earned an additional $14,388 after taxes. You would have had plenty of cash on hand to pay for the television in full.
Avoid Common Credit Card Mistakes
Credit ads and offers that seem too good to be true sometimes lure people. The low monthly payment offerings, nevertheless, will typically end up costing you far more money in the long run.
Before making the purchase, it is a good idea to find out how much a credit card transaction would actually cost. By using a credit and debt management calculator, you may make sure for yourself. Visit a “minimum payment credit card calculator,” which might inform you of the following:
Your overall expense for minimum payments
How many payments are necessary to make the minimum required to pay off the total balance?
How various rates would change the overall costs
By providing low minimum payments and teaser rates, credit businesses typically generate enormous profits. These strategies involve keeping customers in debt for 10, 20, or even 30 years in order to sustain their income. You can think about preserving the money you would have spent on your minimum monthly credit card payments instead of increasing their revenue.
Credit cards can be very useful in our daily lives. After a car accident or other urgent situation, they can offer emergency finances, enabling you to recuperate swiftly. If you must use credit, try your best to pay off your balance in full each month. If you must rely on lesser payments, make an effort to pay at least $10 more than the required minimum and only charge what you can actually afford. You might avoid paying hundreds of dollars in interest just by doing those steps.