Many people coast along making the minimum payment on their credit card each month making them the ideal card customers whom banks love. They pay the minimum which may be typical $5 or 2%, make their payments on time and don’t go into default. Yet month after month the balance on their credit card never goes down, and if additional spending is added the minimum payment goes up but the balance never comes down.
Ironically many believe that they are doing the right thing by paying their cards in this fashion and of course, they are, from the banks' perspective. The bank is making lots of interest from a loyal customer after all. In actuality this is one of the worst things you can do as month after month you are simply paying interest to the bank. The internet provides some free online minimum repayment calculators which demonstrate just what a costly mistake it is to go down the minimum repayment route.
If we take an example of a credit card which has $1000 outstanding balance and an ARP of 14% and assume that no new spending is added to the $1000 balance we can see the effect of only paying the minimum. Most people would just make the assumption that the $1000 will cost them about $140 to repay. Nothing could be further from the truth. In actual fact, the interest charged would equate to a staggering $1028 and would take almost 19 years to clear. Suddenly the fee on a payday loan begins to look cheap in comparison.
The reason for this is that each month the accrued interest is added to the outstanding balance, and that in turn is charged interest, month after month. This compounded interest is not understood by many credit card users who are actually encouraged to just make the monthly minimum payment as it is in the banks' interest to charge them interest.
If in addition to the $1000 outstanding balance further spending is put on the card, the situation becomes worse. If the balance increased through spending and interest to $2000 then the total repayment by minimum payments would be an additional $2245 in interest which would take 25 years to pay off, assuming the interest rate didn’t change.
Sooner or later most people realise that their credit card has managed to amass a large debt even though they make the minimum payment each month and are suddenly faced with a debt they hadn’t fully comprehended.
In order to break this cycle of constant interest more than the minimum payment has to be paid in order to start reducing the actual balance. If funds are tight pay at least something over the minimum to stop the situation getting any worse and do not add any more spending to the card. If your monthly minimum payment is $40 try to pay as much above that as you can each month to begin to reduce the actual balance rather than just service the interest.
Anyone who carries a balance on a credit card and does not clear it in full each month needs to pay more than the monthly minimum in order to prevent the interest piling up and to make some reduction of the balance. To put it in perspective look again at the $1000 balance: with a minimum payment only it would cost $1028 in additional interest, but if instead of the minimum you paid $60 a month the total interest would be $111 and you’d be rid of the debt in just over a year.
If you are now kicking yourself as you’ve only been making minimum payments then take a look at your outstanding credit card balances, find your current interest rate, and check the total costs on an online minimum payment calculator. You could well be in for a nasty surprise but if you adjust the minimum payments and start to overpay it is possible to break the cycle and reduce the debt.
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