Since their introduction in the 1920s, credit cards have been both a blessing and a curse. For those who know how to use them wisely, these little plastic cards can be valuable financial tools, but for those who do not understand the true, hidden cost behind credit card usage, debt can soon destroy financial security and cripple plans for a bright future.
This year, approximately one-half of all American households are carrying an average of $8,000 in credit-card debt, and the typical family has at least 8 cards. For the more than 35 million who are only paying minimum monthly payments, the picture is particularly bleak. What most people fail to realize is the enormity of the extra hidden expense tied into making small minimum payments on credit card balances. It may seem very agreeable to the family budget to make low monthly payments, but most card owners don’t understand how long it will take to actually pay off the debt in full. Because they continue to use the card, they enter a never-ending cycle of paying interest that substantially raises the price of items long after those purchases have been worn out or replaced.
Credit-card issuers count on the impulsive buyer to use the card for items on sale or offered at special prices that are too tempting to ignore. Advertised “one-time-only” offers are also used to lure shoppers to spend beyond their budget, and the convenience of the little credit card makes the process quick and easy. Making small, minimum monthly payments seems so manageable and affordable. However, a look at the actual costs involved in completely paying off that big screen TV, cruise, leather couch or mall shopping spree can be sobering.
For example, a $10,000 four-day cruise that is charged to a credit card at 18 percent annual interest rate will take almost 50 years to pay off in full if only minimum monthly payments are made. The card owner will have paid a total of $38,525 for those four lovely days in the Caribbean, and $28,525 will have been interest charges.
On a smaller scale, a beautiful $2,500 leather sofa might only cost $50 a month in minimum credit card payments. However, each month, only $13.00 of the payment would be covering the cost of the sofa early on. The other $37.50 is the interest charge. Continuing to just make the card’s minimum monthly payment, the sofa will be paid off in 28 years at a total expense of more than $8,000. Furthermore, credit-card companies are often more than willing to continually lower the monthly minimum to keep card owners in debt for the longest possible period of time.
Credit-card debt is the third-largest form of consumer debt in America today, falling behind house mortgages and student loan debts, and it may get worse. Since 2011, card companies have once more relaxed their lending policies to encourage further spending by card holders. Initial offers with “teaser” low rates are designed to tempt more people to experiment with credit card use. However, overuse of credit cards not only taxes the family’s budget but also adds additional stress that can affect personal health, marriage relationships and the well-being of the family. In fact, financial disagreements are listed as one of the leading contributors to divorce statistics in the United States today.
What Should You Do?
Credit cards are not inherently evil in themselves. When used wisely for emergencies or special buys, they can be useful tools for disciplined card owners. Limit yourself to one or two, but do not destroy your other cards or close those accounts. Doing so could negatively affect your credit rating. In the future, only charge what you can pay for in full each month. Remember that even the best sale will be nullified if you must pay additional credit-card interest for the next several months.
If you are already heavily in credit-card debt, try to negotiate lower rates. Pay more than the minimum on each card each month, or focus on the card with the highest interest rate, and pay as much extra as possible until it is paid off in full. Then tackle the card with the next highest rate and so on until all your cards are balance-free. If you tend to be easily tempted, ask to have you card limits reduced to an amount that you can manage each month. Knowing the true cost of credit card usage can help you make wise decisions and take control of your financial future.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
Great job at putting the real cost of credit card interest into perspective. Minimum payments are not what they’re cracked up to be. Utilizing minimum payments comes from the same school of foolish financial thought that bred the idea that credit is free money.
But like you suggested, credit cards are not the problem, uninformed borrowers are.
In addition to your advice to reduce your cards, limits and highest interest balances, it should also be noted that people select a card that aligns with their lifestyle and spending habits. I think people get too easily wrapped up in the idea of incentives and rewards while risking more debt just to achieve points.
To curb the impulse buying, don't keep the card in your wallet. That way you really need to think about it before you make the purchase.