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One of the great conveniences of credit cards has always been the ability to defer payments on purchases over a period of time. You buy that slick new $2,000 flat screen TV now, and pay it off at a comfortable pace with as little as a $40 a month minimum payment.
Unfortunately, most consumers chanting the “Charge It Now, Pay It Later” mantra have no idea just how expensive it is to pay just the minimum monthly payment. Racking up credit card debt on multiple cards and paying just the minimum due every month is one of the worst things you can do for your long-term financial health. Due to the black magic of compounding interest, paying only the minimum monthly payment, particularly on high interest credit card debt, ensures that you’ll be enslaved by debt for a very, very long time.
The minimum monthly payment varies, but it’s typically around 2.5% of the balance owed. Unfortunately, while you pay your balance down by 2.5 % each month, your balance also increases by the amount of interest charged on your credit card. In the case of high interest APRs, this one-step-forward, one-step-back effect becomes nearly impossible to surmount when you only pay the minimum each month.
For simplicity’s sake, let’s say that your credit card APR is at 23.99%. Let’s also assume that you no longer put additional charges on your account. Each month, you pay the minimum payment of 2.5% of the balance. At the same time, however, the balance increases by 23.99% divided by 12 months, or about 2% a month. So the amount left over to pay down the principal owed is 0.5%. The rest of the money goes straight into the pocket of your credit card issuer.
Worse, because of the power of compounding interest, you also pay 2% interest each month on the interest previously accumulated, making the effective interest you pay each month higher than 2%. Further, because the minimum monthly payment decreases as the principal decreases, payments will be stretched out to almost infinity, or at the very least into your old age.
To see how this plays out in real life, let’s take an example. Say you owe $8,000 on your credit cards at a 22.99% APR. If you pay down the balance by a fixed amount of $200 every month, it will take you about six years and five months to pay off the debt. During that time, you’ll pay $7,331.44 in interest. Pretty bad, but at least you’ll be out of hock.
Instead, let’s say you pay only the minimum payment each month. This will start out at around $200, but will then decrease as the credit card balance is reduced. Want to venture a guess at how long it will take you to pay off the debt? Twice as long? Three times as long?
Not even close. If you pay only the minimum monthly payment due each month, it will take you a whopping 49 years and three months to pay off your credit card debt. And if, indeed, you live long enough to pay it off, you’ll have paid $25,340 in interest during that time!
Best tip: Want to turn this to your advantage? Increase the monthly payment on your credit card to $400. It will now take you only two years and two months to pay off your debt. During that time, you’ll pay $2,186 in interest.
To see how long it will take to pay off your own credit card debt at different levels of payment, use this convenient calculator from Bankrate.com. For more tips on how to pay off your credit card debt, see our article, 4 Tips for Dealing with High Interest Credit Card Debt.
