Why Paying the Minimum Due Isn't Good Enough

According to the June 2017 data from the Federal Reserve, Americans have $1.021 trillion in outstanding revolving credit. The national average APR on new credit cards offers is now 16.13%—an all-time high. 

Most people don't look at interest rates when signing up for a credit card. They look at the so-called "benefits" they're getting, such as cash back and travel rewards. No one signs up for a credit card with the intention of not paying the balance off each month. However, the more they swipe and the balance grows, many find it difficult to pay in full. And with that comes interest. 

What makes credit card debt so hard to shake is the way the interest is compounded. So let's discuss what compound interest is. Merriam-Webster defines compound interest as "interest computed on the sum of an original principal and accrued interest." What exactly does that mean? Let's say you decide to open a savings account that has a 10% annual interest rate (this is just an example, as you won't find a savings account with this good of a return) with an initial deposit of $10,000. At the end of the year, you will have earned $1,000, bringing your balance to $11,000. If you keep that balance through the end of year two, you will have $11,000 + $1,100 = $12,100. 

Let's apply that same example to a credit card balance. Most credit cards compound interest daily. A 10% APR is approximately a 0.03% daily interest rate. $10,000 x 0.0003 = $3 in interest. The next day your balance will be $10,003, and you would have to pay interest on that total. The interest will keep compounding until you pay the balance off. Calculate that for 30 days. See how this spells trouble? Compound interest is great for savings accounts, but not so much with credit cards.  

Most credit card companies bet on the fact that many people don't understand how interest works. You think you're being responsible by paying the minimum due on time every month, but after that initial 30-day grace period, interest is charged and so begins minimum payment hell. 

All of this is as scary as it seems. In order to get out of debt and live financially free, you need to understand how it all works. The good thing is that you're reading this blog, so you're taking the first step. Now take the time to read the fine print on your credit card statements. Make a plan to start paying more than the minimum to cut down on the accruing interest and slowly, but surely, you'll start to see the light at the end of the debt tunnel.