By Chelsea Jamison - Seattle Pacific University

As you know, credit card companies allow you to make a minimum payment on your oustanding debt, allowing the principal to accrue interest, in turn giving them more money.

So what is the real cost of making the minimum payment on a purchase? Let’s take a look…

You are out shopping and decide you just have to have the new iPod, but don’t have the cash or savings available to pay for it. You end up using your credit card, and charge $250 (plus tax) on your credit card.

A typical minimum payment on this purchase of $250 would be about $10. The minimum payment is a percentage determined by your outstanding balance which barely scratches the principal amount owed on the purchase during the first few payments. At an interest rate of 19% (pretty typical for a college student), you would be making payments on the iPod for over two and a half years, and end up paying about $320 for it… (that’s over $70 of interest!).

Now you may look at this example and think “That’s not too bad…”. And depending on your circumstances, it may not be bad. You now have a sweet iPod. Sure, you paid a little extra for it, but you had no choice…

But, let’s take this scenario a step further: say you have a $1,000 balance and are paying the minumum payment of $25 per month. Notice the minimum payment is higher now because your principal balance is higher. This would leave you (hold your breath) paying off the principle of $1,000 for over 150 months (roughly 153, depending on your interest rate) and paying an extra $1,115 in interest. Notice that you end up paying more in interest than the principal balance itself! How did we figure out these calculations? Crunch the numbers for yourself.

The smartest option is to always pay more than your minimum payment amount due every month. This will prevent interest from accruing on the principal balance, and save you a lot of money. Remember, every extra bit counts. Even when times are tight, throw an extra $5-10 onto your payment to eat away at the principle, and your debt will disappear at a much faster rate.

Hey, it pays to know this stuff.

View Chelsea's Profile      Subscribe via RSS