Most of us carry a credit card balance. As a matter of fact polls, courtesy of NerdWallet, show that the average U.S. household carries over a $6,000 balance from month to month. It can be difficult to pay that off, especially when typical interest rates on credit cards are in the double-digits.
"But What is an Interest Rate and What Does APR Mean?"
An interest rate is the price you pay for borrowing money. For credit cards that interest rate is normally stated in a yearly rate called an Annual Percentage Rate (APR). Simply put if you have a credit card with a 12% APR that means you will pay 1% interest a month for 12 months a year. According to the Federal Reserve the average APR charged in the 3rd quarter of 2018 was 16.46% in the United States.
The overall credit card debt in America is over $423 billion. Yes billion, with a "B". Add that to over $1 trillion (with a "T") in auto debt and over $10 trillion in mortgage debt you can see why the average person finds it difficult to pay more than the minimum on their credit cards. However, it is important that you find a way.
"If I Only Pay the Monthly Minimum, How Much Interest Will I Pay and How Long Will it Take to Pay Off?"
This is the question to which many of us do not want the answer. If that is the case for you then stop reading now; because we are about to go through it.
So let's say I have $6,000 in credit card debt and my APR is 14.99%. I feel pretty good because at least it is less than the 16.46% that the Federal Reserve stated. Now let's also say that right now my minimum payment is $180 a month; which is 3% of my balance. Most minimum payments on credit cards are between 1-3% of the balance. So, in this instance, if I only pay the minimum (and I don't add any new charges) it will take 15 years and 4 months to pay off the $6,000 debt. Also, I will pay $4,074.73 in interest for a grand total of $10,074.73. Keep in mind that as the balance is paid down my minimum payment is reduced as well. In this example I am paying 3% of the balance each month. So in the last year of paying off this debt my minimum payment would be less than $20 a month.
Yup. So you can see that if you are carrying a balance, and you continue to use the credit card, while you are only paying the required minimum monthly payment, then you will never pay that credit card off.
"How Can I Pay It Off Faster?"
Well maybe I could pay double the minimum payment. That will be expensive up front but not too bad as the principle amount is reduced. If I go that route it will take me about 5 and half years to pay it off and I will pay a little over $1,500 dollars in interest. That is a significant change.
What if I pay the minimum plus an extra hundred each month? In that case I would pay a little over $1,400 in interest and it would be paid off in a little less than 3 and a half years.
But if my minimum payment is $180 a month today, and I am comfortable with that, what if I just pay $180 a month until it is paid off? So I am starting by paying just the minimum but I will pay off more as the principle reduces later. In this case I will pay more interest ($1800) but I will pay it off in a little more than 3 and a half years.
Given the three scenarios above I would just pay the extra hundred a month.
"But I Don't Have Credit Card Debt. Show Me How to Pay My Mortgage Off Faster."
I will tackle that topic in my next blog. Need help with a financial plan? Let’s talk about it. Contact me today at 866.QUEST.01 (866.783.7801).
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