The biggest mistake is not that people use credit, but rather how they use it. Most people determine if they can purchase something based on their comfort with the payment, rather than considering the effect of the interest rate. Most people make “minimum payments” on their debts (about 2.5% of the total owed). That doesn’t seem too bad at first, but interest on a $10,000.00 debt can be astounding. Consider the following options:
0% Interest:
At 0% interest the minimum payment is $250.00 per month and it will take 3.3 years to pay it off. (If you add $100 to the monthly payment, you can pay it off in 2.3 years).
9.99% Interest:
That same $10,000.00 debt still has a minimum payment of $250.00. But $83.33 of that payment is interest and $166.67 goes toward paying off the actual debt. At that rate it will take 20 years to retire the debt at a cost of $4,888.25 in interest alone and a total cost of $14,888.25.
Here’s a rude awakening, if you can afford to add $100.00 to the payment and pay $350.00 monthly, the entire debt pays off in 2.75 years with a total interest charge of $1,468.93. That is a savings of 17.25 years and $3,419.32 in interest charges. That is what minimum payments cost you!
19.99% Interest:
Interest rates are climbing and 19.99% is not uncommon. Our $10,000.00 debt still has the minimum payment of $250.00 but it will take 37.6 years to pay off and the total interest cost is $19,465.67. In this scenario the total cost of the $10,000 debt is $29,465.67.
Here’s a bigger shock; If you can afford to add $100.00 to the payment and pay $350.00 monthly, the entire debt pays off in 3.3 years with a total interest charge of $3,692.44. That is a savings of 34.3 years and $15,773.23 in interest charges. Making minimum payments is costing you over $15,000.00 in interest. Just imagine what you could have done with that money.
Up until now it’s been easy to make those purchase decisions on what we thought we could afford and not look at the ultimate cost of that purchase. It’s OK to consider the payment, but also assess the total cost of the purchase. And never make minimum payments. Making minimum payments is a killer. Consistently pay more than the minimum payment and you save hundreds to thousands of dollars in interest.
Tags: credit, interest rates, minimum payments, purchasing, saving money
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