Credit card spending generally starts out as a convenience. You want to make a large purchase and have not saved up the cash. The store or Credit Card Company offers to finance it “For Free.” This deal is hard to pass up so you apply. Now you are able to watch your new television or use your new riding lawnmower while making small monthly payments over time.
You fail to read the fine print and soon realize that the “free” financing was only for a few months and the minimum payments will not pay it off in time. You also learn that if the balance is not paid off in full by the end of the period, the interest backdates to the original purchase date, making that “free financing” not free at all.
This pattern of convenience spending can result in thousands of dollars in charges very quickly. Carrying a credit card balance initially feels harmless because the monthly payments are low. Yet when you end up with $40,000 or $45,000 of credit card debt, those sums can lead to payments of nearly $1,000 a month or more.
Understanding Your Bill
Recent changes in the law have made credit card bills easier to read. The bill includes transactions for the month, current balance, interest rate and minimum payment due. There is also a place which will indicate the needed payment to pay the card off in a few years and the payoff time if the minimum payment is made.
Making only the minimum payment, if you stop using the card, will often result in a payoff period of 25 to 30 years (if balances are high), and paying more than double for your original purchases due to interest charges.
Understanding Your Payments
Most credit cards charge 18% to 29% for purchases with cash advances being charged a higher rate than purchases. Interest is calculated based on the average daily balance for the month. Let’s look at an example:
Let’s say you have $40,000 in credit card debt over 5 cards, averaging $8,000 per card with an interest rate of 20%. The minimum payment is generally no more than 3% of the balance.
Interest : 20%
Minimum Payment: $240 (8000 X .03)
Interest Payment: $132
Principle Reduction: $108
Remaining Balance: $7,892
Over 5 cards this will result in a monthly minimum payment of $1,200. This is as large as some mortgage payments. Since debt varies by interest rate, balances and terms, you can find more specific calculations for your circumstances by using our debt calculators. This will help you determine how long it will take to pay off your debt making only the minimum payment.
Understanding the Interest Calculation
Interest is calculated by taking the interest rate and dividing it by 365 days.
(20% (interest rate) / 365 (days of the year)) = .055
Multiply .055 by the number of days in the month.
(.055 / 30) = 1.65%
Multiply 1.65% by the average daily balance on the card.
(.0165 X $8000) = $132
This result is the amount of interest owed for the month.
Use the Minimum Payment Calculator below to understand how much you are actually paying in principal and interest charges over time based on the terms of your credit card agreement.
When you realize how little of your minimum payment is actually reducing principle it is easy to see how your finances can turn upside down very quickly. When this happens , many consumers need professional help to get the monthly payments down to a more manageable level and get the debt paid off.
Strategic Consulting has professional counselors who can help evaluate your situation and find appropriate solutions for you.