These days, many people use their credit cards believing that as long as they make minimum payments on their bills, they’ll be ok. But that’s not entirely accurate. Yes, if you are making minimum payments on your accounts, you’ll avoid late fees, your credit score won’t suffer, and your financial situation will look pretty good on paper.
However, you could pay a hefty price for making minimum payments on credit card debt instead of paying off your balance. This is because of interest. Here’s what the true cost of making those minimum payments looks like.
How does interest affect credit card debt?
Interest is how credit card companies make most of their money. When you make only minimum payments, the rest of your balance accumulates interest and a significant portion of your payments goes towards interest and finance charges. Here’s how it works:
Consider this example. While out shopping, you see the big-screen TV that you’ve been eyeing for months. The only problem is that even though it’s on sale, it’s still way out of your budget (assuming you have one). You’re probably thinking, “How much could it hurt to purchase this one item on credit?” Besides, it could be an early Christmas present to yourself.
Let’s do the math. The TV costs $2,500, and we’ll estimate your minimum credit card payment as 2% or $50. If your credit card has an annual percentage rate (APR) of 18%, your $50 payment would cover $37.50 in interest and $12.50 on your $2,500 liability. After you make your first payment, you still owe $2,487.50. Here’s the breakdown for that math:
- Divide the APR (18) by 360 days (12 months x 30 calendar days). That equals .05 (5%).
- Multiply 5% by 30 calendar days. That equals 1.5%.
- Finally, multiply 1.5% by the original balance ($2,500). That equals $37.50 in interest.
So, even though you’re paying $50, your balance only goes down by $12.50. Now you may be starting to see the problem.
What’s the long-term cost of making minimum payments on credit card debt?
The above calculation may not seem like a big deal, but when you see the long-term effect of only making those minimum payments, it might shock you. If you pay only 2% of your total balance due every month until the TV is completely paid off, the real cost comes out to a whopping $8,397, with $5,897 in interest alone! Not only will the TV cost you over 3 times more than the original purchase price, it will also take you 3 decades to pay off.
If the TV costs $8,397 upfront, would you still buy it? Probably not. For that price, you could get a nice used car. However, when you charge it to your credit card and only make minimum payments, you’ve agreed to pay that outrageous amount. Suddenly the TV doesn’t seem quite as appealing anymore.
Use your credit card wisely
Although fulfilling wants is immediately gratifying, it usually isn’t worth the headache and hassle of impending financial troubles. If you have credit card debt, know that you have the ability to turn things around. It’s really just about being realistic and having a plan.
The next time you wish to make a purchase with your credit card, ask yourself if you have the means to pay it off in full and on time. If the answer is no, figure out what the real cost of the item is and determine if it’s still worth buying. Sometimes, delaying short-term gratification for long-term financial stability is one of the best decisions you can make for your financial future.
Tackle your debt head on
Whether you’re currently only making minimum payments on your credit card, you’re already struggling with debt, or you’re just worried about falling behind on payments, it might be time to take action. Freedom Debt Relief is here to help you understand your options for dealing with your debt, including our debt relief program. Our Certified Debt Consultants can help you find a solution that will put you on the path to a better financial future. Find out if you qualify right now.
- Why You Should Never Make Just the Minimum Payment on a Credit Card (Forbes)
- 5 Free Debt Payoff Apps You’ll Want to Use Now (Freedom Debt Relief)
- How to Create a Credit Card Payoff Plan (Freedom Debt Relief)