Credit cards will quickly undo all the effort smart shoppers put into getting great holiday deals. Remember the lines of people camped out for Black Friday savings? Some were in line four days in advance to get the best deals. While this extreme level of dedication towards saving money is questionable (factor in four days out of work into the equation); the use of credit cards can erase most of the savings in less than thirty days. How is this you ask?
Obviously the smartest thing to do each month and the option least used by credit card users is too pay off the complete balance in full. If the balance is paid in full before the end of the billing period, and there is no outstanding balance from a previous month, then there are no finance charges. In this case the consumer is in the clear. This is usually not the case.
If a shopper buys four items for the holidays at the cost of $900.00 on their credit card and then carries that balance for 1 month they immediately owe the additional APR of the card. Let’s assume the APR is a reasonable 12% and the consumer has no previous balance on the card. This smart shopper also got 30% off all purchases by waiting in line at their favorite retailer on Black Friday. The day after the billing cycle of their credit card, if the balance is carried, the savings drops from 30% to around 28%. The $900.00 cost just rose over $1000.00. If the balance on the card is not paid by the next billing cycle then the amount saved decreases to almost nothing and we are in the $1200.00 range. It would have been better to pay cash without the Black Friday savings then to run up a card at 30% off.
The minimum payment a creditor asks for is never the minimum a consumer should pay. Creditors know this and push the minimum payment in several ways. The very existence of the minimum payment listed on the credit card bill often helps influence consumers to pay less. In fact the minimum payment box is often checked by default for online bill payers. This is not deceptive, but it’s also not encouraging good consumer behavior.
Let’s take a look at the cost of making a minimum payment. These are the assumptions:
- Credit card balance is $5000.00
- APR of the card is 12%
- Minimum payment is 4% ($200.00) of the balance
- Only the minimum payment is made
In the above example it would take 114 months to pay off the debt, and the interest costs would be $1600.29. By way of example, if the consumer pays 8% of the balance per month ($400.00) the card will be paid off in 14 months and the finance charges would be $368.40. By doubling the payment you get much more than double the value. A lot more. Consumers should make the largest payments they can each month on credit card bills, and often credit card payments should get priority over other spending.
Jon T. Norwood is a managing partner at Bank Card Finder. This site helps consumers understand and manage personal finance.