Thursday, March 18, 2021

Pay Off Debt Quickly and Get to Know Your Credit Card(s)

Are credit card statements containing holiday purchases still arriving? If so, now is a great time to accelerate upcoming debt payments and get to know your credit card’s costs and features better.  

There are many expenses associated with credit cards including annual, late, and over-the-limit fees, and fees for balance transfers. No expense is as costly, however, as the cost of making minimum payments. It can take over a decade, and over $9,000 in interest, to pay off a $10,000 credit card with an 18% annual percentage rate (APR).

There are two ways to avoid the credit card minimum payment trap: 1. “Find” extra money to pay more than the minimum and 2. Pay at least twice the minimum (or more if you can). Below are specific details:

¨      “Find” Money to Pay More Than the Minimum- Action steps will vary from person to person. Author David Bach refers to small expenses that add up over time as “lattes” and everyone has their own. Examples include eating out, buying expensive coffee, and lottery tickets. Fewer or less expensive “lattes” will free up money to pay off debt faster.

¨      Pay at Least Twice the Minimum Payment- Many minimum payments on credit cards are calculated as 3% of the outstanding balance. Double that payment to 6% of the balance (i.e., twice the required minimum payment) and you can save a substantial sum of both interest and repayment time..

Example: Making minimum payments on a credit card with a $1,000 balance and an 18% APR will cost $684 in interest and take 8 years to pay off. Double the minimum payment from 3% of the outstanding balance to 6% of the balance and the interest cost is reduced to $285 (saving $399!) and the debt is repaid in 4 years.

To fully understand features and terms of your credit card(s), carefully read their disclosures (a.k.a., Schumer box) and/or information found on your billing statement. There, you will find information about the following:

¨      Annual Percentage Rate (APR)- Lenders must disclose all types of APRs (interest rates) including introductory “teaser” rates (e.g., 2.9% for six months), standard APRs, and penalty (default) APRs that are charged for specific infractions such as late payments.

¨      Fees- Examples include late fees, over-the-limit fees, and fees for cash advances and balance transfers. These fees are not included in APRs because only some credit card users pay them.

¨      Grace Period- This is the time period, typically 20 to 25 days, between the posting date of a transaction and the payment due date. A grace period is only available to cardholders who paid the previous month’s balance in full and on time.

¨      Balance Calculation Method- Two common methods are “daily balance” and “average daily balance.” New purchases are generally included. With both methods, the sooner in a billing cycle a credit card is paid, the more days with a lower balance and the lower the daily or average daily balance on which interest is charged.

Once you have read some Schumer boxes, make sure that you are using a credit card that’s right for you:

¨      “Convenience users” (i.e., those who always pay their bill in full and do not pay interest) should look for a long grace period, no annual fee, low fees, and a good rewards program.

¨      “Revolvers” who typically carry a balance forward should look for a low interest rate, no annual fee, low fees, and a long “teaser rate” if the balance can be repaid before the introductory rate ends.

Use this worksheet to compare the costs and features of your current credit card(s) and others that might have more favorable terms.

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