Hey everyone, it’s Finance Fridays. After looking through some of my old posts, I have alluded to Credit Card Debt and how bad it is for you. However, I realized I’ve never talked about it explicitly. So let’s talk about Credit Card Debt.
Stock Photo from: Pexels
Ok, so let’s discuss Credit Card Debt
Remember how I mentioned compound interest before and how powerful it is?
Credit Card Debt is like that, except probably even more powerful, but also against you.
I think everyone kind of knows this, but maybe doesn’t really understand just how bad it is.
Allow me to demonstrate:
Let’s say you decided to splurge for Christmas one year and you ended up going over your budget and had to leave a $2000 balance on your credit card. You have plans to pay it off within the first few months of January, but let’s just say you forget and pay the minimum on your credit card for a year.
In general, the minimum payment is either $25 or 1% of your balance, plus interest and fees, whichever is more.
So in this example, you have a $2000 balance and let’s assume you pay the minimum balance ($25) every month, over the year.
After a normal “Introductory Annual Percentage Rate (APR)” which is usually low, like 0%, then a normal credit card will have an APR of between 15-24%. 15% as long as you are making payments, and increasing up to 24% if you miss two payments, in general.
Since APR is kind of difficult to calculate, let’s convert it into a daily rate which is the APR / 365. In this case it’s 15%/365 = 0.041% per day.
Now the next step is to figure out your “average daily balance”.
If you pay the $25 minimum balance on day 1, then the calculation will be:
($2000 – $25) x 30 divided by 30 which equals: $1975
(this would be more complex if you made multiple payments during the month)
So let’s calculate your first month’s interest:
So then your interest charge for the month utilizes your daily rate and average daily balance.
$1975 x 0.041% x 30 = $24.29
So basically, you paid $25, and accrued $24.29 in interest… that’s… not optimal.
Obviously this is even worse if you keep buying things on this credit card and push the balance higher.
Let’s go a little deeper now.
How long would it take to pay off your $2000 balance if you paid the minimum balance $25.
There are plenty of calculators, but here is one from bankrate. If you actually put in $2000, 15% APR, and $25, it actually spits out infinite months.
The reason for this is because it probably rounds your interest to $25 which is your minimum payment. To make it more reasonable, let’s say it’s $50.
Now let’s use the creditkarma calculator this time.
$2000, 15%, $50
You will pay off your debt in 56 months (almost 5 years) and you will have paid $790 in interest.
However, like I said before, this assumes your balance doesn’t increase. Your minimum payment is technically $50 + any new purchases.
Let’s look at what happens when your balance increases, like $10000.
Use creditkarma calculator again.
$10000, 15%, $150
With a $150 minimum monthly payment it will take 145 months (12 years) to pay off this debt and you will have paid $1635 in interest.
Remember, like I said before, this assumes your balance doesn’t increase. Your minimum payment is technically $150 + any new purchases.
The snowball gets bigger.
The snowball? Yes. The snowball. The problem when people begin to carry a balance on their credit cards is that they end up maxing them out. After maxing out that credit card, they start maxing out another one. Then after maxing out two, they balance transfer some of it to another card… and then end up maxing that one too.
Imagine having 4 or 5 credit cards which are all maxed out with $10000 or so on each of them. That is scary. Then, you hit a snag and miss a few payments on one card and your APR jumps to 25%. Then because of that, you miss another few payments on another one and that one jumps to 25%.
All of the sudden you can’t even make the minimum payments on your cards anymore.
The snowball keeps rolling down the hill until it’s an avalanche.
Credit card debt is like riding a bike…
except the bike is on fire.. and you’re on fire… and you’ve just driven into quick sand, and the quicksand is on fire too. (the original quote is here, referencing college)
also, relevant picture again:
Credit Card Debt is like Cancer to your finances and your retirement.
If you leave it alone, it just keeps getting worse.
If you don’t get rid of all of it, it comes back.
Get rid of it, like yesterday.
If you have to carry a balance on your credit card, then you need to curb your spending and budget until it’s gone.
TL;DR
Credit Card Debt is bad, but it’s hard to really understand exactly how bad unless someone demonstrates it to you.
I provide the numbers for you above.
The snowball is real, and it keeps rolling if you let it… until it’s an avalanche.
… and then it’s too late.
-Sensei
Agree? Disagree? Questions, Comments and Suggestions are welcome.
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