Credit cards are an important part of transacting business. Without a credit card, you may find it difficult to rent a car or reserve a hotel room. Credit cards can simplify life and make it easy to buy online, pay for gasoline, and get in and out of a store quickly. For those of us who pay our balances in full each money, credit cards extend free credit and provide the ease of making one monthly payment. Yet, for those who do not pay their balance in full each month, credit cards usage will result in interest payments and late fees.
Credit card companies make money on (1) transaction fees when you charge a purchase and (2) interest and late fees on accumulated balances. They are incentivized to lend borrowers more than they can repay in order to earn interest, and they encourage borrowers to carry balances by setting low monthly minimum payments. In fact, many companies set the minimum payment so low that it could take as long as 6 – 9 years to pay off one debt even if you did not charge anything else on that account. The interest that would accumulate during this time adds significantly to the cost of the item purchased.
The following example is based on a close friend’s true experience; for this illustration I will refer to him as John. John purchased a riding lawn mower for $3,600 from a well-known retail chain. John charged the mower on a store card at an interest rate of 21 percent. The minimum monthly payment of $98 was calculated so the loan would be repaid in 5 years. Had John made only the minimum payment and made all the payments on time, the mower’s total costs would have been $98 * 60 = $5,880. So the mower was $3,600 at the store but he would pay a total of $5,880 if he made the minimum payment of $98 each month to the card. The total interest paid would have been $2,216, which is more than 60 percent of the original purchase price.
When I met with John, he had been paying on the mower for 24 months. His payment record looked like this:
| Month | Payment | Interest | Late Fee | Balance |
| 1 | $98.00 | $63.00 | $30.00 | $3,595.00 |
| 2 | $98.00 | $62.91 | $30.00 | $3,589.91 |
| 3 | $98.00 | $62.82 | $30.00 | $3,584.94 |
| 4 | $98.00 | $62.73 | $30.00 | $3,579.47 |
| 5 | $196.00 | $62.64 | $3,446.11 | |
| 6 | $98.00 | $60.31 | $3,408.42 | |
| 7 | $98.00 | $59.65 | $3,370.06 | |
| 8 | $98.00 | $58.98 | $3,331.04 | |
| 9 | $98.00 | $58.29 | $3,291.33 | |
| 10 | $98.00 | $57.60 | 3,250.93 | |
| 11 | $98.00 | $56.89 | $3,209.82 | |
| 12 | $98.00 | $56.17 | $30.00 | $3,197.099 |
| 13 | $98.00 | $55.96 | $3,155.96 | |
| 14 | $98.00 | 55.23 | $30.00 | $3,143.19 |
| 15 | $98.00 | 55.01 | $3,100.19 | |
| 16 | 54.25 | $30.00 | $3,184.45 | |
| 17 | $98.00 | 55.73 | $30.00 | $3,172.18 |
| 18 | $196.00 | 55.51 | $3,031.69 | |
| 19 | $98.00 | 53.05 | $2,9786.74 | |
| 20 | $98.00 | 52.27 | $2,941.01 | |
| 21 | $98.00 | 51.47 | $2,894.48 | |
| 22 | $98.00 | $50.65 | $2,847.13 | |
| 23 | $98.00 | $49.82 | $2,798.96 | |
| 24 | $98.00 | $48.98 | $2,749.94 |
Through a misunderstanding of when the first payment was due, John’s first four payments were considered late. Eventually, he reviewed his bill and made a catch-up payment in month 5. He made the next 7 payments on time but then made several more payments late before getting back on track. At this point, John had been assessed $240 in late fees and increased his expected accumulated interest on the loan by $145. The lawn mower’s total expected cost was now $6,265, which was 74 percent more than the original purchase price.
Ironically, at this time, John had some money in savings. We determined that he could use his savings to make an additional payment of $1,000. This payment reduced his expected interest on the loan by $659, making the lawn mower’s total cost $5,606. After making the additional payment, John called the credit card company and asked that his interest rate be reduced. His interest rate was lowered from 21 percent to 12 percent, saving even more in interest.
John learned some expensive lessons about credit card debt, including:
- Make sure you understand the terms of any debt you take on. Ask questions and read the sales agreement carefully. Make sure you know the total costs of the debt and when the first payment is due.
- Never pay late, and never skip a payment. Interest and late fees will apply and will add significantly to the total costs of the debt. Some companies will increase your interest rate if you have two or more late payments.
- Make more than the minimum payment whenever you can. If John had simply rounded his payment up to $100, he would have saved $83 in interest and paid off the lawnmower 2 months earlier. If he had paid an extra $15 per month, he would have saved $503 in interest and cut out 13 months of payment.
- If you find yourself in over your head, call the credit card company and try to renegotiate the debt.
This example is a good illustration to use with your children as they start to earn money and establish their own credit. It will show them the true costs of using credit unwisely and help them to get started on the right path to credit card usage.
To learn more about how to manage your money and improve your credit score, please read my other blogs on finance and money management. My book, Honoring God with Your Money, is a great resource to learn how to manage your money according to godly principles.
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Susan's Reflections 