Compounding Interest and Credit Card Debt
by Brandon Eley ~ June 2nd, 2008. Filed under: Finance 101.
Do you know how much that new TV or bedroom suit is going to cost you by the time you pay it off?
Millions of Americans borrow money every year, and I’d estimate the vast majority of them don’t understand how compounded interest works. Interest can be a powerful tool to earn money (as with investments) or a dangerous financial handicap.
So how much is that $1,000 purchase going to cost you?
$1,000 on a credit card with 23% interest would have a minimum monthly payment of about $20/month (2% of the balance). If you paid $20/month consistently (note that the minimum payment would go down as your balance did) until it was paid off, it would take you almost 13 years to pay it off and would cost you $3,347!
Yes, you can make more than the minimum payment, but the average family has over $8000 in credit card debt. With a minimum payment of $160 (2%) that $8000 in debt would cost $26,783 when paid off!
This isn’t about whether or not you should borrow money, but I hope you can see how dramatic these simple examples show the power of interest.
Just imagine if you always paid the minimum payment, which would go down slightly every month. You would take longer to pay off the debt, costing you even more in interest!
You may look at the examples above and think that you’re better off because your interest rate is lower or because you pay slightly more than the minimum payment. That may be true, but you are still paying huge amounts of interest over the course of the debt.
Considering most credit card purchases we make are probably impulse buys, those impulse purchases end up costing us an arm and a leg. Remember the interest next time you’re thinking of swiping that plastic.