One of the great things about using a credit card is that you can buy now and pay later. But some consumers take the pay-later concept to an extreme — they pay only the minimum amount due on their card’s outstanding balance each month and end up paying the maximum costs. The minimum monthly payment on most credit cards is usually calculated as a certain percentage (often around 2 percent) of your total balance.
Your payments include both interest and principal (the amount you borrowed). When you pay only the minimum payment, most of it goes towards interest, which is why it takes so long to pay off the original debt. You wouldn’t pay $7,000 for an item that is clearly marked with a $2,000 price tag, would you? Yet that is exactly what you’re doing when you buy it using a credit card with an 18% interest rate and then only pay the minimum balance each month. Credit card interest is wasted money that you could have used instead to help reach your financial goals.
The best advice is to ignore the card’s minimum payment and pay as much as you can every month. Paying down a credit card with an 18% interest rate should be one of your very first financial priorities — the rate is probably a lot higher than any other loans you have and you’re unlikely to find other investments to beat that rate. Switching to a lower-rate card can make a big difference, too.
If you need to buy on credit, at least do it with your eyes wide open. If you’re already in debt, use these tips to get out and get ahead:
- Don’t get any deeper into debt. Save the credit card with the most favorable terms and cut the rest up.
- Pay more than the minimum balance. Much more.
- Shop around for cards with low interest rates, but beware of come-ons that offer a low introductory rate and then take a big jump.
- Move balances on cards with high interest rates to cards with lower interest rates.
- Use your savings to pay down debt. It makes no sense to earn 1 to 3% interest on your savings account while paying 12 or 15 or 18% interest on credit cards.
- Come up with a written plan for reducing your debt systematically.
- Add up all the money you spend each month on credit card payments, and think about what you could do with this money if you weren’t paying it to the credit card company.
The bottom line is that credit cards are what you make of them. If you let them, they can easily overwhelm you. However, if properly managed then credit cards can be your friend and ally in accumulating wealth and security, all while using someone else’s money.
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