When you have an outstanding balance on your credit card, making at least the minimum payment each month is a good initial step. If these payments don’t strain your overall budget, it may tempt you to put your payments on autopilot and disregard the total cost of your debt.
Delia Fernandez, the founder and president of Fernandez Financial Advisory LLC, explains that our fast-paced lifestyles often lead us to prioritize other matters, particularly when we are not in a financial crisis. However, this lack of action can be costly, especially considering that the average credit card interest rates were at 20.4% in November 2022, according to the Federal Reserve. According to NerdWallet’s 2022 American Household Credit Card Debt Study conducted by Harris Poll, households in the United States with revolving credit card debt are paying an average of $1,380 in interest this year.
Nevertheless, there is positive news: dedicating even a small amount of time and money to changing your payment habits can yield substantial benefits.
It is important to consider the total cost of interest rather than just the monthly payments. Although the gradual accumulation of interest payments might appear manageable on a monthly basis, it is crucial to recognize the significant impact of interest over time.
Bruce McClary, senior vice president of membership and communications at the National Foundation for Credit Counseling, highlights the potential consequences: “If you’re only able to make minimum payments and you’re paying the average interest rate, it could cost you thousands over many, many years if you’re paying down a balance of $10,000. It’s stunning how much it could cost you.”
For instance, if the minimum credit card payment is generally around 2% of the total amount owed, a $10,000 balance would require $200 monthly payments, assuming an interest rate of 20.4%. In this scenario, it would take approximately nine and a half years to become debt-free, with $12,508 spent on interest alone, more than doubling the total debt cost.
However, this calculation assumes that you refrain from accumulating additional debt. If you continue using the same card for new purchases, you will find yourself caught in a cycle of debt. Switching to using debit or cash for everyday expenses is advisable to avoid accruing further interest.
McClary emphasizes the importance of confronting uncomfortable details: “You really want to sit down and look at the details that might make you uncomfortable because it’s better to know than not to know. Even if your budget is balanced each month and you’re making payments on time, you really need to know how much your debt is costing you.”
Implementing small changes can have a significant impact on saving money. There are two approaches to reducing the cost of debt: increasing payment amounts and lowering the interest rate.
Let’s return to the example of a $10,000 balance to demonstrate the potential impact of higher payments. Suppose you feel comfortable allocating an additional $10 per week or $40 per month towards your debt. By making monthly payments of $240 instead of $200, you would save $4,966 in interest and pay off your debt nearly three and a half years sooner. Even if you are already making more than the minimum payment, paying even more can make a tangible difference.
Alternatively, negotiating a lower interest rate with your credit card issuer is another option. Decreasing your interest rate from 20.4% to 18% (while maintaining a $200 monthly payment) would reduce your interest expenses by $3,886 and shorten your repayment time by a year and seven months.
Consider these methods to lower your interest rate:
- Call and inquire: Contact the number on the back of your credit card and ask about the possibility of obtaining a lower interest rate. Even if the answer is no, there are no negative consequences for asking.
- Transfer debt to a lower-interest option: If you have good or excellent credit, consider a balance transfer credit card with a 0% interest rate promotion. This can provide you with nearly two years to pay off your debt without incurring any interest. Alternatively, you could explore the option of a personal loan, which may offer a lower interest rate compared to your credit card.
To truly make a substantial impact on reducing the cost of your debt, combine the strategies of increasing your monthly payments and seeking a lower interest rate.
For instance, if you allocate $240 per month towards a $10,000 debt at an 18% interest rate, you would save $6,697 in total interest payments compared to the starting point, and you would pay off your debt almost four years earlier.
“It’s the compound interest at higher rates that can be detrimental,” says Delia Fernandez. “You want to be the one who understands and earns interest, not the one who pays it and enriches credit card companies.”
In conclusion, while making the minimum monthly payments on your credit card is a good start, it is crucial to consider the long-term consequences of accumulating interest. By making small adjustments to your payment habits, such as increasing your monthly payments or negotiating a lower interest rate, you can significantly reduce the overall cost of your debt. Take the time to understand the details, assess the impact on your finances, and make informed decisions to regain control over your financial future.
