While out shopping, you spot an irresistible deal on a garment you have wanted for quite some time. You do not have the cash on-hand or in your bank account to cover the purchase, so you hand the cashier a credit card to cover the cost. When the statement arrives, you make the minimum payment without giving the total balance much thought. The cycle continues until you finally do the math and realize the outstanding balance drastically exceeds the total amount of purchases made.
True Cost of Credit Card Debt
There are several components of the credit card debt equation.
Annual Percentage Rate
The APR, or annual percentage rate, is the amount of interest applied to the outstanding balance each month. On average, cardholders can expect to pay 14 to 25 percent, depending on creditworthiness. It is also important to know that you can be assessed a penalty APR if payment is remitted after the due date.
Fees
In addition to APR, credit cards come with an array of fees, some which are unfair to you as a consumer and can quickly accelerate your balance:
- Annual fee: A set amount assessed annually to cardholders
- Balance transfer fee: A percentage charged to transfer balance from one credit card to another
- Cash advance fee: A fee charged if cardholder withdraws cash from available credit line
- Late payment fee: An amount assessed if payment is made after the due date and grace period
- Over-the-limit fee: A fee applied when the balance exceeds the amount of available credit
- Dormancy fee: A fee assessed if the card sits idle for an extended period
- Foreign transaction fee: A percentage charged for all transactions made while traveling abroad
Minimum Payment Trap
It may seem like a wise idea to only pay the minimum each month since it is affordable, and your account will remain in good standing. However, doing so will cause the debt balances to increase rapidly, keeping you in debt for quite some time.
This occurs because the minimum payment is typically comprised of two to four percent of the balance plus interest and fees that have accumulated for the month. So, each time you only pay this amount, you are barely touching the principle and whatever balance remains will be rolled over into the next month's calculation.
Scenarios
The following scenarios demonstrate how much your credit card debt really costs over time if you only make the minimum payment.
The following chart shows how much making different payments, such as a minimum payment and higher amounts, on low-APR cards will cost over the course of payments, as well as how long it will take you to pay off the card if you never charge another thing on it.
| Starting Balance | APR | Monthly Payment Amount | Balance After Year 1 | Balance After Year 2 | Balance After Year 5 | Balance Payoff | Total Payments |
| $4,000 | 9.9% | $160 (Minimum Payment of 4%; adjusts as balance decreases) |
$2,718.40 | $1,847.73 | $579.88 | 8 years and 5 months | $4,999.96 |
| $4,000 |
9.99% | $210 | $2,325.93 | $1,352.50 | $265.52 | 6 years and 7 months | $4,727.61 |
| $4,000 | 9.99% | $260 | $1,986.08 | $986.12 | $79.20 | 5 years and 5 months | $4,570.88 |
| $8,000 | 9.9% | $320 (Minimum Payment of 4%; adjusts as balance decreases) |
$5,436.79 | $3,694.86 | $1,159.75 | 10 years and 3 months | $10,051.29 |
| $8,000 | 9.99% | $370 | $4,983.47 | $3,104.39 | $750.42 | 8 years and 9 months | $9,686.91 |
| $8,000 | 9.99% | $420 | $4,651.92 | $2,705.04 | $531.85 | 7 years and 10 months | $9,480.50 |
The following shows the same scenairos on a high APR credit card.
| Starting Balance | APR | Minimum Payment of 4% (adjusts as balance decreases) | Balance After Year 1 | Balance After Year 2 | Balance After Year 5 | Balance Payoff | Total Payments |
| $4,000 | 24.99% | $160 | $3,170.72 | $2,513.36 | $1,251.87 | 13 years and 1 month | $8,097.13 |
| $4,000 | 24.99% | $210 | $2,718.41 | $1,847.42 | $579.84 | 8 years and 10 months | $6,524.03 |
| $4,000 | 24.99% | $260 | $2,325.97 | $1,352.51 | $265.91 | 6 years and 9 months | $5,827.22 |
| $8,000 | 24.99% | $320 | $6,341.45 | $5,026.76 | $2,503.71 | 16 years and 1 month | $16,441.23 |
| $8,000 | 24.99% | $370 | $5,819.19 | $4,232.88 | $1,629.09 | 12 years and 5 months | $14,217.86 |
| $8,000 | 24.99% | $420 | $5,436.79 | $3,694.85 | $1,159.74 | 10 years and 8 months | $13,153.81 |
The following chart shows the cost of the charges and the payoff time if you make additional charges of $100 per month while continuing to make a fixed monthly payment.
| Starting Balance | APR | Fixed Monthly Payment | Balance Payoff |
| $4,000 | 9.99% | $200 | 4 years and 1 month |
| $4,000 | 24.99% | $200 | 7 years and 3 months |
| $8,000 | 9.99% | $400 | 2 years and 7 months |
| $8,000 | 24.99% | $400 | 3 years and 4 months |
This chart shows how much it would cost and how long it would take to pay off a sofa purchase for $1,200 on a new credit card making minimum payments.
| Starting Balance | APR | Minimum Payment of 4% (adjusts as balance decreases) |
Balance Payoff | Total Payments |
| $1,200 | 9.99% | $48 | 5 year s and 4 months | $1,464.01 |
| $1,200 | 24.99% | $48 | 7 years and 11 months | $2,256.15 |
Here's a chart for a leather coat purchase for $200 on a new credit card.
| Starting Balance | APR | Minimum Payment of 4% (adjusts as balance decreases) | Balance Payoff | Total Payments |
| $200 | 9.99% | $15 | 1 year and 2 months | $212.88 |
| $200 | 24.99% | $15 | 1 year and 3 months | $236.74 |
Quick note: The minimum payment will decrease as your balance decreases, but it is best to stick with a set amount each month. Otherwise, it will take longer to pay off the credit card balance.
Smart Debt Management
First and foremost, stop using the credit cards if you are currently saddled down by debt and cannot seem to find a way out. Next, create a spending plan to identify expenses that can be eliminated and re-allocated to your debt-payoff fund. Then, begin making those larger payments and continue searching for ways to reduce expenses to pay the balances off faster.
To determine how much you will need to pay monthly to get out of debt, check out the credit card calculators from Bankrate or CreditCards.com.
A Better Alternative
Are you adamant about using credit cards to earn rewards or other perks? Be sure to pay off balances before the interest accrues each month. The grace period prior to the accrual of interest can be found in the terms and conditions of your cardholder agreement. Otherwise, practice discipline by always using cash to make purchases. That way, you will avoid wasting your hard earned cash on credit card interest and fees.
