The Actual Cost of Credit Cards – All You Need to Know
Credit cards are great if used correctly. They can help you build credit and provide funds to make larger purchases. However, credit cards can be dangerously costly if not managed correctly. Knowing what credit cards truly cost and understanding how to properly manage your credit card is absolutely critical. Continue reading for all you need to know about the actual cost of credit cards.
MINIMUM PAYMENTS, APRs, AND HOW THEY ARE CALCULATED
You will often hear two buzzwords associated with credit cards: minimum payments and annual percentage rates (APRs). It is important to know what each of these represents and how they are independently calculated.
With regard to minimum payments, these are required monthly and usually set at ~2% of your total balance. For example, if you get a new credit card and use it to purchase a new couch for $1,000 then your first minimum payment is 0.02 x $1,000 = $20.
APR refers to the interest you pay to borrow money through your credit card. Unless you pay off your full balance each month, you owe interest since you essentially “borrow” funds by not paying off all that you owe. If your APR is 20%, then your interest charge will be 20% / 12 months = 1.67% per month. Ultimately, this percentage will dictate how much of your minimum monthly payment is allocated to paying off the base amount you owe and how much is allocated to interest obligations.
INTEREST BURDEN OF MINIMUM PAYMENTS
If you make only the minimum payments on your credit card each month, your interest burden can make the original credit card balance extremely costly. Going back to our example where you purchased a couch for $1,000, your minimum payment was $20 for the first month with an APR of 1.67%. Let’s now calculate how much of that payment goes toward interest: 1.67% x $1,000 = $16.70 interest allocation.
This means that of your $20 minimum payment, only $3.30 went toward actually paying off the original balance, and you still owe $996.70. Now you can see just how expensive credit cards can be! If you continued with only paying the minimum each month, it would take 16+ years to pay off the original balance. Your payments would total $3,126, which means you paid an exorbitant $2,126 in interest!
WAYS TO AVOID CREDIT CARD DEBT
As you can see, falling into credit card debt can happen very easily, and pulling yourself out of debt can be difficult. This is how credit card companies make their money – by profiting from customers who are enticed by the APR and low minimum payment offers. Here are some helpful strategies to avoid credit card debt:
- Use a minimum payments calculator – you can enter your balance, APR, and minimum payment percentage to determine how long it will take to pay everything off
- Pay your monthly balance in full – this is always the best option if financially feasible given the high credit card interest rates
- Invest your money instead – if you know you won’t be able to pay off your balance in full but can delay the purchases you had planned, invest your money in a savings or brokerage account to earn returns instead!
Overall, credit cards are not always bad – but they can be if you do not manage them correctly. Be sure to assess your financial situation thoroughly before making the decision to get a new credit card. It can save you some serious expenses in the future!
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