Balance is a good thing… right?
Sometimes because of unexpected costs or not enough planning, you end up carrying a balance on your credit card. But what, exactly, does it cost when you don’t pay your credit cards in full each month?
Let’s start by defining a few important terms when it comes to credit:
Principal – The amount you originally borrowed. Yes, anything you spend on your credit card is borrowed money.
Interest – What your credit card charges you for the privilege of borrowing money. This is usually presented as an annual percentage rate.
Compound Interest – Interest that is added to your principal … which is then charged interest. Interest on your interest is how credit card debt can stack up so quickly.
Minimum Payment – The smallest amount of money you can pay in order to keep your credit card and not damage your credit score.
Credit Score – This is essentially a measure of how good you are at fulfilling your financial commitments. A good credit score can help you buy a house or a car, get a loan, start a business, or even get you better interest rates.
Interest grows your debt
Let’s use an example. Say you’ve got $1,000 on a credit card with a 19% interest rate. That’s not bad, right? $1,000 isn’t that much at all, and 19% is a pretty standard interest rate. So, let’s say you put $20 each month toward paying off that debt, which is an approximate minimum payment. Do you want to know how long it would take to pay that balance off? More than eight years! And what would it cost you? About $997, which is basically doubling your debt load! Also, that’s with only paying off your principal with no additional borrowing.
With compound interest, every dollar you leave on your credit card ends up costing you more and more. It’s a powerful thing that can be used to your advantage when it comes to saving, but that’s another topic.
A credit card can be good
There’s an obvious solution here, right? Just don’t get a credit card!
Well … it’s not quite that simple. In order to build credit, you need to use credit. So, if you hope to own a home one day, or even get a car loan, you’ll have to work to build your credit. The best way to do this is to use your credit card and pay off the entire balance each month.
Some good tips on using credit with care are:
- Keep your credit limit sensible
- Use credit cards for recurring payments that are a regular part of your budget
- Plan for larger purchases
- Don't use credit cards as a tool to spend more than you earn
- If you can’t trust yourself with your cards, leave them at home
Credit is an important part of your financial life, but carrying a balance, or not managing it well can lead to a struggle with debt. Always be mindful of the decisions you're making when using a credit card.