In today's world of online shopping and bill servicing, credit cards
have become almost an essential part of our everyday lives. No one would
argue that they don't make life easier, but it's also true that they
have a dark side in that it's all to easy to build up debt.
Of course, it's simple to advise against getting into debt by
overspending with your card, but that advice is perhaps a little hollow
for people who have already built up a balance. If you're lucky, that
balance is not yet too much of a problem, but one almost guaranteed way
of setting your debt on the slippery slope is to continue spending with
your card while only making the minimum monthly repayment required by
your card issuer.
Each month when you receive your statement, the minimum amount you have
to pay will be clearly shown, and many people choose to have this amount
repaid automatically through their banks. This makes it easy to keep
your account up to date, and gives the illusion that you're keeping on
top of your card balance.
The problem lies in the size of the repayment you're making. In the
early days of plastic, the minimum repayment level was generally around
5% of the balance, but over the years this has drifted inexorably
downwards with 2-5% to 3% being the norm nowadays, with some cards going
as low as 2%-
Why is this a problem? Surely a lower repayment amount is attractive, as
your credit will cost you less each month, putting less pressure on
your budget? This is true to an extent, but the problem lies in the long
term. To get an idea of how bad an idea only paying the minimum is, we
need to look a bit more closely at your credit card statement.
As well as showing the familiar annual interest rate, or APR, your card
statement will also show the monthly rate of interest charged on your
balance. A typical card might show a rate of around 1-6% a month. In
simple terms, this means that each month you will be charged 1-6% of
your balance in interest. Compare this to a 2% repayment, and you'll see
that over three quarters of everything you pay is swallowed up in
interest charges, leaving your original debt virtually untouched.
This situation is bad enough, but it gets worse when you consider that
the interest rates charged on other ways of using your cards such as
instant cash or overseas use can be much higher. Monthly rates for
withdrawing cash, for example, can be nearly as high as the minimum
repayment percentage. If you withdraw a significant amount of cash
within a month, it's quite possible that the whole of your repayment can
go towards interest, with your debt level not reduced at all.
So even from this quick look at repayment levels, it's plain to see that
if you only make the minimum payment required on your statement, you'll
be prolonging the life of your debt by many years and vastly increasing
the amount of interest you'll be paying in total. How can you avoid
this?
The best way is to set up automatic payment of the minimum, so that
you'll be sure that every month you'll at least be staying within the
terms of your credit agreement and not risking damage to your credit
rating. Then, at the end of the month, make an extra payment of as much
as you can afford without borrowing from another source. Even if you
can't afford to pay a large amount, every little helps especially as all
of it will count towards reducing your balance and not servicing
interest charges-
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