Most of us know that having credit card or department store debt is not the best form of debt. Many, however, don’t realize what the actual effect on your wallet is through carrying credit card debt.
The biggest cost in carrying credit card debt is the high interest rate. While most credit card companies attract new customers by offering zero percent interest, reading the fine print along with the offer reveals that the zero percent interest rate is very short term. After the initial period is over, the interest rate jumps significantly, with the average rate being 21%.
What does this mean for the average person? Let’s go through an example where you purchase a new refrigerator using the store’s credit card. You picked that store because they are offering zero percent interest for 90 days. You think, “I can pay off that $700 refrigerator in 90 days, easy.” Then, your child gets very sick and you are focused on getting her well and paying the medical bills. Before you know it, the 90 days are over and you receive a bill from the store for $736.75. What happened? Since you didn’t pay off the entire balance before the end of the 90 days, the store charged you interest for the 90 days.
You start making the regular payments of $26.38, which according to the original agreement would have the refrigerator paid off in three years. However, since they already charged you $36.75 in interest, it will now take you longer because your starting point is not $700 but $736.75. To be specific, you will have to make almost three extra payments to take care of that extra interest.
Late fees are another danger of financing a purchase through credit. Continuing on with the example, through the course of the three years, you occasionally forget to make the payment on time and end up being charged late fees of $35 every time you are late. Each time that happens, your amount due increases by the amount of the fee and you end up paying extra interest on the fee. If you were late with the payments just twice a year, you will accumulate $210 in fees over the three years. Paying off that additional amount will take you at least another eight months of payments.
By the time you make that final payment, you will have paid more than $1,200 for that $700 refrigerator and it will now be four years old. By using credit and paying late a few times, you just gave the store $500 more profit on that refrigerator.
To learn how to keep that $500 in your pocket, consider attending our workshop, “Banking, Credit and Savings” on January 9, 2016.
Judith Ackland has more than 26 years of experience in accountancy and financial planning, including seventeen years as a CFO of a diverse business. She started Crystal Financial in 2010 to help a wide array of individuals, families, and business owners better understand their finances and how good financial management could help them achieve their goals. Judith has an MA in Professional Accountancy from the University of Nebraska at Lincoln as well as a Certified Public Accountant Certificate and a Certified Financial Planner designation.
