Friday, January 16, 1998
The Credit
Trap
by Robert Sheard
([email protected])
Credit Cards are mixed blessings. If you like the convenience of carrying a card instead of checks or lots of cash, and you pay off your entire monthly credit card bill regularly, credit cards can be wonderful. There are enough cards around that charge no annual fee that this kind of cash-management strategy is appealing to many people.
The "credit trap" is sprung for most Americans, however, in that they charge without any plan for future repayment. The mind-set is that as long as they're making their monthly minimum payments, they're doing fine. But are they?
Let's look at a possible scenario. The average family in America carries a monthly credit card balance of approximately $4,500. Most credit card companies require a minimum monthly payment of between 1.5% and 2.5% of the outstanding balance (or $10, whichever is higher). And it's not unusual to find interest rates in the 18% to 19% range on many credit cards.
Just how long do you imagine a credit card holder would be paying off that $4,500 balance if he only paid the minimum 2% payment each month and was getting charged 18.3% interest (or 1.525% a month)? Let's look.
The interest on the $4,500 the first month would be $68.63, bring the account to $4,568.63. The 2% minimum payment on that balance is $91.37. After the first month, then, the new total balance is $4,477.25. You've reduced the original debt by a whopping $22.75. The other $68.62 is the credit card company's fee (the interest).
Let's jump ahead a year. After twelve months of paying the minimum payment, the overall balance has been paid down to $4,234.49. You've paid $980.08 throughout the year, but only $265.51 actually went to pay off the original amount; the rest went to the credit card company's bottom line. Get the idea this may take a while? You got it!
Assuming the credit card holder continues to pay the monthly minimum and doesn't ever use the card again, it will take… are you sitting down?… 44 years and 1 month to pay off the entire balance. That's right, an average $4,500 credit card loan can take the majority of one's adult lifetime to pay off if one only pays what the credit card company requires each month. Care to take a stab at the total dollar amount paid to shed that $4,500 debt? You'd have paid $17,016.16. Ouch!
The lessons here should be obvious:
--Don't ever fall into the trap of simply paying off the minimum each month. You'll never get out.
--Have a plan regarding credit card purchases before you buy. Credit cards are fine when used with a realistic plan, but the credit card companies are banking on you paying the minimum for many years to come.
--Shop around and get the best permanent interest rate you can get (not the 6- to 12-month teaser rates).
--And most importantly, pay off any open balance as quickly as possible. That 18% rate you're baying the credit card company is a guaranteed tax-free investment return if you're not having to pay it to someone else.
[For more on how to handle debt Foolishly, visit our new Credit Area in the Fool's School.]
Have
a similar tale?
Talk about it in the Fribble Message Folder!
[Did you know that you can pen a Fribble, yourself? We welcome submissions from readers. Just click here and read "What's a Fribble?".]