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Did you know that as of 2004 the average American family holding a credit card had approximately $4,000 worth of debt on their credit cards? Even worse, the average rate of interest on this debt was an astronomical 17-20%. Yikes! It's tough for anybody to get ahead financially with that sort of baggage. This article will shed some light on credit card debt and the benefits of getting out of it. Credit Card Debt
Most of us are familiar with credit cards. As mentioned earlier, U.S. statistics show the average family has a credit card balance in excess of $4,000, and pays around $800 a year on credit card interest. In fact, credit card debt accounts for a very sizeable chunk of total consumer debt, which in the U.S. is about $1.5 trillion. This translates into roughly $19,000 per household. Clearly credit cards are an important part of our day-to-day lives, which is why it's important for consumers to understand the effect of that interest on them. What Is Interest?
Interest, typically expressed as an annual percentage rate, is the fee for the privilege of borrowing money. This fee is the price a person pays for the ability to spend money today that would otherwise take time to accumulate. Conversely, if you were lending the money, that fee/interest compensates you for giving up the ability to spend that money today. (If you want a deeper look at the significant factor of time, check out Understanding the Time Value of Money for a quick recap.)
An Example: Discovering the Benefit of Increasing Your Payments
Let's say John and Jane both have $2,000 debt on their credit cards, which require a minimum payment of 3%, or $10, whichever is higher. Both are strapped for cash, but Jane manages to pay an extra $10 on top of her minimum monthly payments. John pays only the minimum.
Each month John and Jane are charged a 20% annual interest on their cards' outstanding balance. So, when John and Jane make payments, part of those payments go to paying interest and part goes to the principal.
Here is the break down of the numbers for the first month of John's credit card debt: - Principal Repayment: $26.67
- Remaining Balance: $1,973.33 ($2,000 - $26.67)
- Principal: $2,000
- Interest: $33.33 ($2,000 x (1+20%/12))
- Payment: $60 (3% of remaining balance)
These calculations are done every month until the credit card debt is paid off.
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