The Awesome Drain of Credit Card Debt

(Estimated savings: tens of thousands
of dollars, depending on your situation)
I have a rule that I only buy with credit
cards what I can pay off in a month. If I
didn’t follow this rule I would set myself
up for financial disaster. The main
reason it would lead to disaster is that:
1) credit cards have enormous
interest rates - sometimes 400%
more than a standard bank loan and,
2) credit cards only require that you
pay a small minimum off each month.
This combination of high interest and low
minimum payments means that you could
easily end up paying a huge amount of
interest over your lifetime if you didn’t
promptly pay off your card balance.
Here is an example. Let’s say you
have just purchased something with
your credit card that cost $10,000. The
interest rate on your card is 20% and
the minimum payment is 3% of the
outstanding balance. If you payed off this
purchase by only paying the minimum
payments each month then by the time
you paid it off completely (which, by the
way, will take you 41 years) you would
have paid $12,036 in interest. However
if you pay this off in one month by
transferring it to a low-interest (let’s say
6%) line-of-credit account and make
disciplined payments of $300 per month
then you will pay the entire loan off in
3 years and pay only $966 in interest.
Many people might argue that nobody
is foolish enough to keep a $10,000
purchase on a credit card for 41 years
and pay only the minimum balance even
when the outstanding balance becomes
small. They have a good point because
that balance eventually becomes small
enough to pay off in a lump sum. However
they miss two points. First, the bulk of the
interest is being paid when the balance
is too large to be paid off in a lump sum.
Second, as soon as the fi rst purchase
is paid off, another purchase is usually
made, starting all over again the cycle
of high interest rates and low payments.
Some people do much worse. It’s
not uncommon for someone to have
$50,000 in credit card debt. Here’s how
their numbers shake out. Assuming they
never buy another thing on their credit
cards and they only make minimum
payments - it would take them 51 years
to pay it off and over that time they would
pay $60,229 in interest. Even if they
only made the minimum payments until
the outstanding balance got down to
$10,000 and then paid it off in one lumppayment,
it still would take almost 10
years and would cost $48,270 in interest.
Large monthly payments are the
answer for many people trying to pay
off their debt. Let’s go back to the
fellow who had the $10,000 purchase
at 20% interest. If he made disciplined
payments of $300 per month (which is
roughly equivalent to his fi rst minimum
payment) he would still have that loan
paid off in 4 years - although he would
have paid $4,718 in interest. And, as
pointed out earlier, if he also had moved
it to a 6% interest line-of-credit account
then it would only have cost him $966 in
interest, and would be paid off in 3 years.
So to summarize - if you want
to get out of credit card debt:
1) Make every effort to move the debt
to a low interest account. A line-of-credit
account is ideal. Another choice is to
move it to another credit card that offers
low interest on transferred balances.
Just make sure you don’t use the new
card to make more purchases. Cut it
up, or lock it away at a relative’s house.
2) Make as large a monthly payment
as you can possibly muster.
Increase it until it really hurts!
3) If the debt was originally formed as
a result of an unrestrained and reckless
urge to shop - DESTROY THE CREDIT
CARDS and all records of the number and
expiry date. And don’t replace them again.
4) Plan your purchases, budget so you don’t
get surprises, and use cash when possible.
5) If you don’t have the means, don’t buy
it. You probably don’t need it anyway.

Scrooge