The only man who sticks closer to you in adversity than a friend is a creditor.
If you’re only going to read one article on this site, it needs to be this one.
Paradoxically to me, debt has usually been viewed by my peers as a convenient tool they can use to attain things they want before they have the means to do so.¬† If they were a little low on cash, they would just put it on their credit card.¬† If there was a 75% off deal on a pair of pants that were normally $200 and they spent all their money, they would just stick in on their credit card and pay for it with their next pay-cheque.
That was always an attitude I never adopted for myself because my father would drill into me these four words: “Never get into debt.”
I didn’t understand it when I was little.¬† As many people do, I never saw the harm in getting something now and paying for it next month, when the money came in.¬† That’s what credit cards were for, right?¬† Or loans, for that matter.
It wasn’t until I started seeing the statistics on credit card interest rates and doing the math on balances carried forward a month that I realized why my father swore off carrying a debt himself, and advised me to do the same.
And so, I bring this useful bit of advice to you.
Credit Card Companies are not Friends Giving you a Loan
In fact, they’re the least friendly bunch of people who could possibly offer you a loan.¬† (Haha, okay well perhaps not the least friendly, but they definitely rank up there.)¬† It may seem like they’re letting you use their money so that you have a chance to get something before you actually have the money, but in fact the reason they’re letting you use their money is so that they can make more money off of you.
Right now, MasterCard’s interest rate is 19.99%.¬† For ease of use, we’ll just say that MasterCard’s interest rate is an even 20%.
So, simply put, every time that you carry a balance, you get charged 20% interest. (For the uninitiated, that means that¬† you pay back 20% of whatever balance you carried over on top of the original balance.)¬† Let’s look at that a little more carefully.
Let’s say you’ve spent all your allotted budget on entertainment for this month and you see these headphones you want that are $100.00.¬† Normally, your budget for entertainment for the month is $400.00, so these are something you would handily be able to afford during your next pay-cheque.¬† But, you’re about to go on a trip and having them now would be really handy, so you decide to put them on your credit card and wait until next month to pay it off.
But there’s a 20% interest rate, so what you’re really paying for these headphones by carrying a balance is $120.00, instead of the $100.00 they were marked at.¬† But maybe you think, what the hell, it’s worth the extra $20.00 to get them early.
Now let’s say you carry a balance of $100.00 for five months at 20% interest.¬† By that I mean, simply $100.00.¬† You pay off the interest that you’re charged each month, but you don’t pay the $100.00, meaning for each month you pay $20.00 in interest.
In that five months, you will have paid MasterCard the same amount of money you would have paid for your headphones for absolutely nothing.¬† You will receive no product and no service (Other than the ease of swiping a credit card.) and have lost $100.00
That’s no picnic, but that may not be enough to scare you off either– not to worry.¬† I have plenty more statistics that will do that.
Let’s say you buy these $100 headphones and all you do is pay the minimum balance, which on a hundred dollars is usually about five bucks.¬† You get charged $18.00 in interest on that.
So next month you only pay the minimum balance again, which is still $5.00.¬† So low! you think, and you pay the minimum balance and don’t have to worry about it again until next month.
This month your interest is higher, since you carried more of a balance.¬† You carried $113.00 ($118.00 – $5.00) which means you’ll pay an interest of $22.60
Next month your balance is now up to $135.60, but you look at your minimum payment only to discover that it’s still only $5.00.¬† What the hell, you think, why should I pay it now when I only need to pay $5.00?¬† You pay the $5.00 and let it carry again.
Now your interest is $26.12, added on to the balance of $130.60 ($135.60 – $5.00) which you carried over.¬† Now your balance is $156.72 and that minimum payment is still five bucks.
I’m sure you see where I’m going with this.
To demonstrate in a more straightforward way, here’s a chart that shows you just how much you would pay over a year if you started with $100.00 and only paid the minimum payment each month.¬† I don’t know the actual minimum payments for the values in between $100.00 and $1,000.00 (I know from experience that $1,200.00 has a $25 minimum payment.) so for the sake of demonstration, once it hits $500 the minimum payment will be calculated as $10.00.
Month 0: $100.00
Month 1: $115.00¬† ($100.00 + 20% = $120.00 | $120.00 – $5.00 = $115.00)
Month 2: $133.00 ($115.00 + 20% = $138.00 | $138.00 – $5.00 = $133.00)
Month 3: $154.60 ($133.00 + 20% = $159.60 | $159.60 – $5.00 = $154.60)
Month 4: $180.52 ($154.60 + 20% = $185.52 | $185.52 – $5.00 = $180.52)
Month 5: $211.62 ($180.52 + 20% = $216.62 | $216.62 – $5.00 = $211.62)
Month 6: $248.94 ($211.62 + 20% = $253.94 | $253.94 = $5.00 = $248.94)
Month 7: $293.73 ($248.94 + 20% = $298.73 | $298.73 – $5.00 = $293.73)
Month 8: $347.48 ($293.73 + 20% = $352.48 | $352.48 – $5.00 = $347.48)
Month 9: $411.98 ($347.48 + 20% = $416.98 | $416.98 – $5.00 = $411.98)
Month 10: $489.38 ($411.98 + 20% = $494.38 | $494.38 – $5.00 = $489.38)
Month 11: $577.26 ($489.38 + 20% = $587.26 | $587.26 – $10.00 = $577.26)
Month 12: $682.71 ($577.26 + 20% = $692.71 | $692.71 – $10.00 = $682.71)
Total Interest Paid on $100 over a year: $652.71 ($582.71 + (10 * $5.00) + (2 * $10.00) = $652.71)
That’s on $100 over a year.¬† You would pay $652.71 on absolutely nothing. For a $100.00 pair of headphones you didn’t want to wait for.¬† You can imagine the kind of damage that carrying a balance $1000 would do to the amount you owe.
These amounts don’t go away when you pay the minimum balance– they increase.¬† Thinking that credit cards are free money is a grievous mistake that can cost you an enormous amount of money in the long run– money that can be best put towards other things (Like actual goods and services.) rather than being spent because you didn’t want to wait for that set of headphones.
Debt can add up at an alarming rate, and suddenly you don’t have any money to put away to savings because you’re spending it all on your credit card bill– the worst part is that if you look at the case above, by month 12 if you decided to pay $400.00 on that bill, you would have paid nothing towards your original balance.¬† In other words, those headphones still would not be paid for, even though you just spent four times the original price on your bill.
There’s a reason your minimum balance is so low
Credit Card companies don’t give you a low minimum balance to do you a favour.¬† They give you a low minimum balance because the higher your actual balance is, the more money they make in interest.¬† They want you to keep paying that minimum balance, because most of the time it isn’t even a fraction of the interest you’ll be charged when you carry forward.
That way every month your balance increases and so does the amount of interest you’re paying.¬† Understand that credit cards are the worst possible form of debt you can get into.
Literally every other loan you could think of charges a smaller interest rate than credit cards.¬† Car loans are anywhere from 0.9% to 5%, (Which still adds up fast, since your balance is usually in the tens of thousands of dollars.) student loans are less, mortgage rates are less, even bank loans are less.
Credit card companies have set up a system in which it is incredibly easy to let your interest payments become several times larger than the principle you started with, thus ensuring you remain in their debt.
Having a credit card can be handy.¬† I use mine for large purchases that won’t ring through on my debit card due to withdrawal limits, when I’m in a hurry or for places that don’t accept debit cards.¬† However, I always go home and pay off the balance the moment it appears on my statement.¬† Always.¬† No exceptions.¬† I have never carried a balance in my life and have consequently never paid so much as one cent of interest to a credit card company.¬† This will never change.
Remember that these people are running a business, and you are a customer.¬† They still make money every time you use their card because they get kickbacks from retailers per swipe, but they make far, far less than they would if you carried a balance.¬† Those who carry their balances and only pay that minimum payment per month are the true money makers for these companies, and so they encourage everyone to do the same.
Do yourself a favour and pay off your credit card each and every month.¬† There’s no point in spending money you don’t have when you end up paying extra when you finally do pay it off.¬† Sometimes it seems like there’s a deal you just can’t pass up, but you don’t have the money for it so you stick it on a credit card.¬† Remember this during those times:¬† It’s not a deal if you don’t have the money.
If you get something for %15 off, put it on your credit card and carry the balance, you have essentially paid 5% more for the item than you would have if you had bought it normally.¬† And even if it’s something like %50 off, within one month that’s reduced to %30 off if you carry a balance.¬† It’s not a deal unless you can pay for it right away.
If you have any questions or comments, I’d love to hear from you.¬† This is by far one of the most important issues I’ve ever written about here, and it’s something we all have to deal with no matter who we are.¬† If you didn’t know about how this all worked, or just hadn’t thought about it, I hope this helped.
Don’t get into debt.¬† It is just not worth it.