Are credit cards evil? No, they aren’t. They are actually a safe and convenient way to pay for goods and even get rewards like miles or cash back. The danger of credit cards is they can become TOO convenient and you become unable to pay it off every month. Let’s take a close look at credit card debt. According to nerdwallet.com, the average US household credit card debt stands at $15,191. What is the true cost of that debt? Not just the interest you pay, but what are you giving up when you have to pay interest instead of investing it? What is that money worth to the credit card company?
Let’s use the example of an individual with a credit card balance of $5,000 at 18%. Let’s also assume this person is getting 5% on their currently invested dollars. Now take a look at the graphic below.
What is this calculation telling us? First let’s look at number 1. In the first year this individual is going to pay $986 of interest. That is a little more than $82 a month. I know many people who would gladly use their credit card and feel like paying $82 a month of interest isn’t too painful. Now let’s jump to 40 years from now and that number becomes $39,433 of interest paid into the lender’s pocket. Still painless? Number 2 is showing us that if this individual was able to keep that $82 a month and invest it at their 5% rate of return, they would have $119,087 at the end of those 40 years. If I had a choice of paying $82 into a lender’s pocket, or keep the money for 40 years then buy a Lamborghini Gallardo, I would take the latter.
Number 3 shows us what that $82 a month is worth to the lender. Once they get your payment, they are just lending that money right back out at 18%. In this example our individual is sending the lender $986 of interest and they are lending it back out over and over again so at the end of that 40 year period of time they have amassed $6.68 million. That explains how the credit card company can afford to send me letters in the mail three times a week asking me to sign up for a card!
So that is the true cost of credit card debt. That is why I always pay off cards at the end of the month. How do you manage the use of your cards?