We show you how to avoid the credit card trap that could double your debts.
Paying with plastic is something many of us do without a second thought. Indeed, statistics from the British Bankers Association reveal that in January 2008 we made 154.6million transactions totalling £12.5billion. Credit cards have become an easy, convenient form of spending. But what’s also easy is ignoring reality. Credit cards are a form of borrowing; at some point, unfortunately, the money has to be paid back.
Luckily, credit card providers have come up with a way to ease the pain for the shopaholics amongst us. By setting low minimum payment rates you aren’t faced with the daunting prospect of paying back the entire balance of your card at the end of the month. Who hasn't felt relief when, after a month of heavy spending, you need only fork out £10 to avoid harsh default penalties? Even better, paying back on average only 2-3% of your card's balance a month means you are left with more disposable income from your salary.
But are we really so lucky? In this case, first appearances are most certainly deceiving. You may feel that by meeting the minimum repayments you are slowly but surely reducing your debt and you are. The problem is that the pace is glacial and the interest rates high. Take a credit card with an average APR of 15% and a minimum repayment rate of 2%. This means that 1.25% of your repayment is going towards meeting the monthly interest and a miniscule 0.75% towards your debt.
Apply this to a debt of £1,000 and it will end up taking 20 years and 3 months to completely repay. What's more, the credit will end up costing you over double the original amount borrowed due to the accumulation of £1,188 in interest. It's not hard to see how the problem intensifies with larger debts and higher APR’s. By merely making the minimum repayments you are helping you creditor to earn a nice profit.
However, it doesn't take a Herculean effort to turn this situation around. Simply by repaying an extra 1% each month, and not making any more transactions on your credit card, you can halve the time it takes to repay to 11 years 8 months and the cut the amount of interest paid on the debt to £579.
If this still sounds like scarily long time the solution is to further increase your repayment rate. By setting a fixed and realistic monthly repayment amount the sum which is servicing the debt rather than interest will increase.
In an ideal world we would pay off the balance of our credit cards at the end of each month avoiding paying any interest. In the real world, credit cards are often most useful for situations we hadn’t quite budgeted for and a bit of leeway with repayment is a welcome relief. However, it is within our power to use them wisely. Be aware of the true costs of convenience and avoid being lulled into a false sense of comfort by merely making the minimum repayments. In a nutshell, the faster you pay off the balance the better.
Compare Credit Cards via money.co.uk
