Minimum repayments = Maximum Pain!
Without a doubt, the biggest pitfall with using a credit card is how easy it is to run up debts. Since credit cards generally charge far higher interest rates than other forms of credit like a mortgage or car loan, debt on your card can quickly grow from a molehill into a mountain - particularly if you only repay the minimum amount every month.
Example: Mary, a 22 year old childcare worker has a $2000 credit card debt on a card with a typical 16% interest rate. Her card issuer requires she make minimum monthly repayments of 2.5% or $10, whichever is greater. Assuming she stops all spending on her card, how long does it take Mary to repay all her debt if she only repays the minimum every month?
Believe it or not, it will take Mary until her 38th birthday to fully pay off her credit card debt even though she isn’t using the card to make any more purchases. In the end, she will have also paid $2005 worth of interest charges -she will end up repaying over half her original debt. If these calculations included the annual fees most card issuers institute, Mary’s children and grand children would probably end up having to finish paying the debt for her!
Making only the minimum monthly repayment is attractive because it seems to free up your money for other things. This, however, is an illusion - whilst it may be true in the short term, you will end up losing big in the long term through interest charges and annual fees.
Many people also choose to make the minimum repayment because they feel that their debts are so massive that it would be pointless to start trying to pay them back. No matter how dire your situation may seem this is never the case. As a matter of fact, even paying slightly more than the minimum can make a huge difference. If Mary had made a flat repayment of $60 a month - that’s only $2 a day - she will have her debt paid off in less than 4 years and only wind up paying $662 in interest. A mere $2 a day will allow Mary to save $1343 in charges and repay her loan 12 years faster then if she only made the minimum monthly repayments.
Summary: As tempting as it might be, making the minimum repayments is never a good idea. With the comparatively high interest rate credit cards charge as well as annual and other miscellaneous fees your best bet is to get out of credit card debt as fast as possible - and repaying the minimum is the absolute worst way to do this. Although you’ll initially have less money to spend if you repay more than you have to, you’ll wind up saving big in the end.
This should be written on the front of every credit card application. This is common sense but it seems like many people fall into the trap of minimum payments.
A few years ago I head California was going to require that it say right on the statement how long it would take to pay off the balance if you only pay the minimum payment. I wonder if they ever did? That would wake some people up.
Mom, I believe that was actually proposed in the US Congress. It didn’t get far, either way. Credit card companies rally don’t want customers to know things like this! Although they have been required to raise the minimum payment from 2% of the balance to 4% of the balance.