Credit cards have caused financial pain for millions of consumers. It’s easy to run up a balance, but as too many people find out the hard way, it’s a lot harder to get it paid down. Even if you’re diligent about getting your debt repaid, high interest rates work against you, creating a big headwind that’s hard to fight against month after month.
Even your credit card issuer’s own policies can tempt you into staying in debt a lot longer than you should. By simply ignoring your card company’s advice and doing what most people would logically think of as the right way to pay down debt, you can get your card balances zeroed out years sooner. Below, we’ll show you how to do it and why so many people don’t.
The minimum payment trap
The problem that so many credit card holders run into has to do with the minimum payment provisions that card companies have. You’d think that a lender would want to get repaid as soon as possible, but that’s actually not the case for credit card companies. The opportunity to charge double-digit interest rates in an environment where mortgage loans generate less than 5% interest for lenders encourages lenders to keep those card balances as high as possible for as long as they can.
As a result, the minimum payment provisions that many card companies use don’t do much to pay down your outstanding balance. One common provision involves having someone repay the greater of 2% of their balance or $25 each month. That might sound like a lot, but when interest charges eat up more than half of those payments, there’s not much left to apply toward reducing the principal you owe.
How you can stay in debt for decades
As a simple example, say that you have a $5,000 balance on a credit card that charges a 17% annual interest rate. Using the 2% or $25 rule, your minimum payment will start out at $100. Of that amount, more than $70 will go toward paying the interest on your $5,000 balance. The remainder will go toward paying down your debt slightly.
The next month, your balance will be about $30 lower, so your minimum payment will be incrementally lower, at $99.42. Because you owe slightly less money, your interest due will be lower, but it won’t drop by as much as the minimum payment did. Over the ensuing months, you’ll find that you pay down principal at a slower and slower rate, as your minimum payments fall.
It’ll take you almost 10 years just to get your debt halfway paid off if you follow the strategy of paying just the monthly payment. Even after $25 minimum payments kick in around year 20, it’ll still take you another seven years to zero out your balance. Over that 27-year period, you’ll pay more than $10,000 in interest charges — double the initial amount you borrowed in the first place.
The better choice
Fortunately, there’s a way to slash the time it takes to get out of debt and the interest you have to pay. Since you have to make that initial $100 minimum payment, it’s reasonable to think that you can afford to keep making $100 payments in future months as well. Even if that’s the only thing you change, the impact is immense.
In the example above, if you make sustained $100 monthly payments on your credit card, you’ll get that debt paid down in a bit more than seven years. You’ll pay roughly $3,750 in interest over that time frame — producing interest savings of more than $6,000 along the way. The simple reason: Your $100 monthly payments ensure that an increasing amount of money goes toward paying down principal month after month, and the resulting faster decline in your card balance cuts your interest charges, creating a positive feedback loop that makes it easier to get your debt paid off.
It does take discipline to make more than the monthly payments you owe on your cards. Your bank is never going to encourage you to do so, and in fact, you can expect financial institutions to dangle offers that make it easier for you to take on more debt.
But being out of debt is a financial necessity, especially when it comes to credit cards. With such high interest charges, it pays to dig yourself out of credit card debt as quickly as you can, and simple strategies like this one can make it a whole lot easier.
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