The Dark Side of Compound Interest

It is so easy to pull that little piece of plastic out of your wallet when you see something you want. It doesn’t even feel like you’re actually spending money.

The amount of each individual purchase is usually small. But the trouble comes when all those little purchases add up over time. Throw a big purchase or two into the mix, and things can get out of hand pretty quickly.

That’s because of compound interest.

Last week we talked about how you can use compound interest to build wealth. But, compound interest also has a dark side.

If, like most Americans, you make only minimum payments on your credit cards, you know exactly what I’m talking about. If you don’t pay off your card balance each month, you accumulate interest. The next month, you pay interest on what you spent… but you’ll also are pay interest on last month’s interest charges. And at 12 – 15% interest, that really adds up over time.

If you continue to make new purchases, you can even end up in a sort of credit card black hole, never able to pay it off.

For example, let’s say you buy a new tablet for $199 on your credit card at a 14.3% interest rate.  If you make only minimum payments, it will take 15 months to pay it off and cost you a total of $225. In other words, you gave the bank $26 for the convenience of borrowing $199 to buy the tablet.

That doesn’t sound so bad. But how many people do you know that buy 1 thing on their credit card at a time?

Here’s a more realistic situation:

You buy that same tablet on that same card. And you go out to the movies, buy some clothes, and go out to eat a few times. At the end of the month, your credit card balance is $482. You make your minimum payment and carry on with your life.

The next month, you spend another $300 on your credit card and make the minimum payment. And the month after that, and the month after that for about a year. Before you know it… the balance is maxed out at $5000.

At 14.3% interest, with a minimum payment of $119, it will take 59 months to pay off that balance. That’s nearly 5 years and over $2,020 in interest! And that’s only of you never charge another thing on that card. If you keep charging… you’ll keep paying. Forever.

Dark side… indeed. And that’s what many Americans face every day.

Try it out for yourself with your credit card balances:

Online Calculator

Credit card balances can get out of hand very quickly, leaving you scraping to get by each month. And if you miss a payment… you’ll get hit with late fees and default interest rates of 20% or more.

Yes, having (and using) a credit card is an important part of building a good credit score. But… you DO NOT have to carry a balance to build good credit. By paying your balance off each month, you’ll avoid added interest charges and may even build a good credit score even faster.

Knowing how to use a credit card wisely is essential if you want to remain in control of your finances…and your future.

For some great tips of getting yourself out from under big credit card balances, read this article.

If you have any questions, please give us a call at 770-952-5168 or contact us online.

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Other articles that may interest you:
3 Instant Credit Score Fixes
Keeping the Wolves at Bay – Safely Communicating With Debt Collectors
7 Ways to Improve Your Credit

This information is intended for informational and educational purposes only and not as legal advice. If you have concerns about your credit report, harassment, identity theft, illegal collections activity, garnishments, or property liens, you should consult an attorney who specializes in consumer rights and defense.

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