The credit card is a wonderful invention, allowing you to pay for longed for items or unexpected bills and spread the payments out. But a credit card must work for you rather than you constantly working to catch up with the payments which can be difficult when the credit card supplier starts to pile on the interest.
The perils of compound interest
Compound interest is a good thing when you have an interest-paying savings account. In a nutshell, compound interest is interest earned on top of interest. As an example: £1000 at 5% daily interest earns £50 which gives a new balance of £1,050. Day two would earn 5% on the £50 already earned which equals £2.50 so this means your balance is now at £1,052.50 and so on. If you leave the money in the savings account without touching it the balance would keep increasing, compounding daily.
With credit card debt, the compound interest added is what makes the overall debt continue to grow. This is especially true if you only ever pay off the minimum payment each month. Credit cards are usually sold with a headline catching APR (annual interest rate). However, when they are anything between 5.9% and 15.9% it can be difficult for the average person to work out what is the best deal for them. Add to this the fact that the APR figure bears little relation to the amount of compound interest you end up paying as interest is piled upon interest on a daily basis.
Credit card companies usually calculate the minimum monthly payment at around 2% so this means if you only ever pay off the card at 2% each month you’re never going to get near the APR rate or the compound interest accumulation. This is because the minimum payment only goes towards paying the interest, not the original debt. In short, the minimum payment never pays off the debt.
Avoid falling into debt
Ideally you should try to pay off the full amount of your credit card debt each month; in this way you are charged no interest at all. But if it isn’t possible to pay off the full balance at least try to pay as much as you can to reduce the amount –and interest – owed.
The problem is that we live in a society where things are expensive and it can be difficult to keep up with paying bills, putting fuel in the car, clothing the family and so on and often the only way for many people is to rely on credit cards. It is so easy to get behind on payments and fall into debt but if this happens to you don’t despair because there are ways to cope with debt.
Minimise credit card interest
Many people stay with the same credit card year after year but savvy users know to keep switching. Look for cards which offer 0% interest deals and which allow you to make balance transfers. Providing you make efforts to clear your debt within the 0% interest period you can beat the interest rate trap.