Credit cards are a valuable alternative to paying cash for more enormous expenditures. They can also serve as a stepping stone toward a better financial future by providing an opportunity to begin or add to a credit profile. But the accurate price of credit cards becomes apparent only after you add up the interest and other fees. Using credit may not be as handy if the interest adds up to a higher total price than paying cash. You can see the actual cost of credit in this example.
Remitting Only the Barest Essential Payment
Getting in the habit of paying the bare minimum on your credit card account is a common blunder. To make merely the minimal payment on a debt means to slow the rate at which the debt is reduced. In the meantime, interest continues to build gradually on what you owe. Your minimum payment might not even be enough to cover the interest for the month if the interest rate is too high.
The Formula For Determining Required Monthly Payments
Payment thresholds are often calculated as a fixed percentage of the total debt. The percentage is typically around 2% but varies widely amongst different cards. You should know that your minimum payment is applied both to the principal and the interest. The initial deposit in this example was $2,50.
- We can get to.05% by dividing 18% by the number of days in a year (360).
- Increase the quantity of 1.5% each month, based on a 5% daily rate.
- Multiply 1.5% by the initial sum of $2,500 to get the interest due, which is $37.50 ($38 rounded up).
What Exactly Is The Price Of Using Credit Cards?
Debt repayment would take 333 months if only 2% of the balance were paid each month. If you owe $2,500, you’d have to make payments for roughly 29 years before being completely out of the hole. Probably the TV would have broken before you could afford to pay off the loan. The interest alone would amount to $5,896.48 after 28 years of payments. It turns out that the actual price of the TV for you is $8,396.48.
Put Your Money To Work For You By Using Interest.
However, interest can also be viewed from its ability to increase one’s financial resources. Just think how much more money you could have made if you had saved that $50 over 28 years. It would have been a significant sum even at today’s low-interest rates.
If you opened a brokerage account offering 5% interest and deposited $50 monthly for 28 years, you would have $2,800. Calculate the amount of taxes you would have owed if a rate of 25% had been applied to the money made.
Credit Card Traps: How to Stay Safe
Too-good-to-be-true credit offers and promotions lure many people. However, when you look at the long-term effects, the low monthly payment offers will usually cost you much more.
Before purchasing a credit card, it is wise to determine exactly how much the transaction will cost. Use a debt and credit management calculator to see for yourself.
Having Cash On Hand Is Preferable.
What is the most efficient method of making a purchase? Put aside the money you’ll need, and then go ahead and buy it. If you shop this way, you can avoid paying interest or additional costs on purchases made with credit. What you see is what you paid for. It’s not always feasible, of course. There will be occasions when you cannot pay. One alternative is to use a credit card to make the purchase and then pay the balance in full when the bill arrives.
Effects of Interest
Scenario: you use a credit card with an 18% interest rate to buy an $800 laptop. It would take an incredible 94 months to pay off that debt if you merely made the minimum monthly payment ($16).
Even more alarming is the interest you’ll pay throughout that time, which totals more than $689. That brings the final cost of that $800 laptop to close to $1,500. Take into account the fact that this applies to a low-cost item. If you don’t pay off your credit card balance in full every month, the interest you accrue could add up to an astronomical sum over time.
Interest isn’t the only reason that using a credit card to purchase can cost more money. For example, the annual fee on some credit cards is due whether or not you use the card during the year. You may find several credit cards in today’s market that don’t charge an annual fee. Unless the card has other perks that are more valuable to you, there’s no point in signing up for one that levies such a fee.