Credit Card Guide
 
Follow Us  twitter facebook You Tube Google+
 
Credit Cards > Credit Card News > Credit Cards General > Don’t Let Compound Interest on Credit Cards Take You to the Cleaners



 
 

Don’t Let Compound Interest on Credit Cards Take You to the Cleaners

 
By Eva Norlyk Smith, Ph.D.
May 22, 2009
tools
tools
email print comment
tools
SHARE

Take a guess: How long will it take to turn a penny into $10.7 million if you double it every day? 30 years? 10 years?

How about 30 days? Due to the power of compounding interest, if you double a penny every day, it will actually turn into $10.7 million in only 30 days. Compound interest is such a powerful force that Albert Einstein referred to it as the eighth wonder of the world.

The concept of compound interest is great when you put money in the bank because it can turn a small investment into a fortune over 30-40 years. Unfortunately, when it comes to credit card debt, the power of compound interest works against you. Unless you know how to take the bite out of compound interest, it will keep you in the stranglehold of credit card debt for a long, long time.

So what exactly is compound interest? Each month, the interest your credit card company charges on credit card debt becomes part of the debt principal for the next month. So next month, you also pay interest on the interest. This repeats itself the following month, but now you also pay interest on the interest of the interest from the previous month, and so on. This is compounding interest. In this example, the interest compounds once a month. Some credit cards, however, compound the interest daily, making it an even more powerful force to surmount.

Compound interest grows exponentially. It starts out slowly, and then speeds up and grows faster and faster. In the example of the penny that doubles each day, after 15 days, it has still only turned into $327—a long way from $10.7 million. But that $327 keeps doubling, and at 20 days it’s $10,485. Double that for another 10 days, and you’ve got your $10.7 million.

When it comes to credit card debt, it fortunately doesn’t double each day, or we’d all be bankrupt. However, as this example shows, the longer one holds on to debt, the more the power of compound interest works against you.

There are three factors that increase the power of compounding: high interest, high levels of debt, and holding the debt for a long time. This deadly combo will speed the accumulation of compounding interest and will deny the ability to paying off debt for a very long time. Unfortunately, for many people, this is exactly what happens when they pay only the minimum due on their credit cards each month.

For example, let’s say you have $10,000 in credit card debt at a 19.99% APR. If you pay only a minimum payment of, say, 2% of the balance owed each month, due to the power of compound interest, it will take you 84 years to pay off your credit card debt. During that time, you’ll pay around $48,000 in interest, almost five times the original amount charged. Such is the power of compounding interest.

Want to know how to neutralize the force of compounding and save BIG money on your credit card payments? See our article on How to More than Double Your Money with Your Credit Cards.


Share 
 
     

 
 

VIEW RELATED STORIES

A marvel in history: The credit card - Check out our infographic and article that explore the history of the credit card, from paper loyalty cards of the 1920s to the future of plastic ...

5 ways medical credit cards can trip you up - A medical card can provide you with a quick way to pay the bills, but some say these cards can be bad for your financial health ...

6 tips cut bank overdraft confusion - Despite Federal Reserve rules designed to make bank overdrafts clear to consumers, many customers get socked with overdraft fees ...

ALL CREDIT CARD NEWS & ADVICE ARCHIVES >>

 
     

 
  If you are commenting using a Facebook account, your profile information may be displayed with your comment depending on your privacy settings. By leaving the ‘Post to Facebook’ box selected, your comment will be published to your Facebook profile in addition to the space below.

Our editorial content is not sponsored by any bank or credit card issuer. The comments posted below are not provided, reviewed or approved by any company mentioned in our editorial content. Additionally, any companies mentioned in the content do not assume responsibility to ensure that all posts and/or questions are answered.

Comments Closed

 
     


 
Secure SSL Technology
Secure SSL
Technology
 
Twitter Facebook You Tube Google+
About Us Privacy Policy Editorial Team Terms of Use
Contact Us California Privacy Rights Media Relations Site Map

Close X