Understanding the Cost of Credit Card Debt

Many people carry balances on their credit cards. Since credit cards tend to have high interest rates relative to other kinds of debt, purchasing things on credit and not paying them off right away can be a very expensive habit.

Use the "Debt Payoff Calculator" tab (the second tab) on the Loan Calculator Download Loan Calculatorspreadsheet that you used earlier to answer the following questions:

Assume you have a $5,000 balance on a credit card that charges 18% annual interest, and that you want to pay it off over the next 5 years (round all answers up or down to the nearest dollar and don't use dollar signs):

How much do you need to pay each month?

How much total interest will you pay over the 5 years?

Assume you have a $5,000 balance on a credit card that charges 24% annual interest, and that you want to pay it off over the next 5 years (round all answers up or down to the nearest dollar and don't use dollar signs):

How much do you need to pay each month?

How much total interest will you pay over the 5 years?

Assume you have a $5,000 balance on a credit card that charges 24% annual interest, and that you want to pay it off over the next 3 years (round all answers up or down to the nearest dollar and don't use dollar signs):

How much do you need to pay each month?

How much total interest will you pay over the 3 years?

Takeaways:

• It pays to shop around for a lower-interest credit card if you anticipate that you will need to carry a balance (i.e., if you can't pay it off each month).

• Paying a little more each month to pay off your credit card faster can save a lot in interest.

• If you have various kinds of debt and you are trying to pay them off, it usually makes sense to try to pay off the highest-interest debt (credit cards) first, by putting any extra money toward paying off that debt while making the minimum payments on everything else.

• Don't just stop paying your loans or credit card debt. This can have severe consequences for your credit score, which will impact your future ability to access credit, and can impact your ability to rent an apartment or even get a job (landlords and employers can request and view your credit reports). The section of the reading called "Managing Your Borrowing" (starting on p. 15) provides information about how to manage your debt, including tips about what to do if you are in over your head.

• It's especially important that you don't just stop making student loan payments. If you are enduring financial hardship, you may be eligible to suspend payments for a while through deferment or forbearance plans, but those are often not available to people who have already missed payments. Keep in mind also that if you stop making payments, interest on the loan keeps accruing and you can end up owning much more than you owed in the first place (the interest you don't pay gets added to the loan balance and then you end up paying interest on the unpaid interest). Further, student loans are usually not wiped out in bankruptcy, so they are very hard to get out of altogether. Bottom line: keep making your payments, or go to the lender to see if deferment or forbearance is a possibility.