The cost of credit card debt

Do you ever really look at your credit card bill? Do you fully understand just how much is going to interest every month? I know I didn’t look for many years, and I paid the price for it.

APR: Annual Percentage Rate. This is the rate at which you get charged interest for using your credit card, if you do not pay the balance to zero every month. I have had cards as high as 21% APR, and as low as 15-ish%. Anymore, it seems like most cards are in the high teens to low 20’s with their APR rates.

Let’s assume the APR on your favorite credit card is 18%. What this means, is over the course of a year, you will be charged $180 per $1000 of debt. But it gets worse, because credit cards utilize compound interest: the left over balance is added to the next months balance, and interest is taken from that. So, let’s say you have $1000 on your card, and you only pay off $200, that leaves $800 that gets charged interest. So, the next months statement comes, and you had spent another $1000 that month. So, your total balance is now $1800 ($800 from previous month, and $1000 from this month). Now you will be charged interest on that whole $1800, less your payment. It adds up very quickly.

To determine your monthly interest charge, take the APR and divide it by 12 months. The numbers become staggering when you stop and think just how much money you are giving away if you do not pay your credit card balances to zero EVERY month. This is how credit card companies make money. They don’t want you to pay your balance to zero every month because, if you did, they would not make as much off of you. Especially those that have zero yearly fees. By the way… NEVER GET A CARD WITH A YEARLY FEE!! Not ever! But that’s a totally separate topic of wasteful spending.

We know that your 18% APR is costing you $180 per $1000 every year. Now, take that $180 per year, and multiply it by, say, 10 years. That’s $1800 over the course of 10 years. And most likely, if you are like I was, you did this year after year, and with a lot higher balances than $1000.

Credit cards are necessary evil. They also come in quite handy during emergencies. But you must understand them, and you must know what you are being charged to carry a balance over every month. I do my best to pay all of my cards to a zero balance every month. The way I look at it: if I do not have the cash in the bank, then I shouldn’t be buying it anyways. Of course, like I mentioned, emergencies happen and it is nice to have a credit card waiting to be used for them.

Categories: Financial Health

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