The Truth About Credit Card Debt

The Average American carries or has carried credit card debt at some point in his life. Figures are all over the board as to just how much that figure is. The numbers being bandied around are anywhere from $2,000 to $8,000. What the average person is carrying, however, is not as important to consumers as each person's personal situation. A consumer should focus on how much he owes and how to understand the intricacies of credit card debt, payments and interest rather than worrying about the "average American."

Significance

The interest rate on your card is extremely important to people who carry credit card debt. You are charged interest for the privilege of borrowing money, according to Investopedia. Typically, the higher credit risk you are, the higher rate of interest the credit card companies will charge you to use their card. To get the lowest interest rates, you must not max out your credit cards, never make late payments and, most important, never skip payments. Otherwise, if you are able to get a credit card, you will certainly pay dearly for it in interest.

Misconceptions

If you do have sizable credit card debt, the worst thing you can do--besides not paying the monthly payment--is to make only the minimum payment. This is because of the compounding interest the credit card companies charge you, which is quite different than simple interest, which is simply the amount you borrowed times the interest rate, according to The Simple Dollar. So, 10 percent interest on $1,000 is $100. This is what most people think they pay when they have to pay interest on their credit card, but that is not the case. The truth is much harsher.

Features

Credit card companies are not charging you simple interest. They are charging you compound interest. The way the compounding interest works, it will take you a very long time, if ever (depending on how much you owe) to pay off your card if you only pay the minimum each month. Compound interest is the interest that is added back to the original amount of money borrowed. Most credit card companies compound interest monthly. So, using simple interest from the $1,000 at 10 percent interest, you would owe $1,100. Compounding the interest gives you a different figure, because you have to recalculate the balance at the end of each month. Working out compounding interest, you would add 1/12th of the interest to the original amount, which would be 1/12 of 10 percent of 1,000, which is $8.33, so the starting balance would be 1,008.33 at the start of the second month, repeated each month.

Considerations

The higher your interest rate is, the greater the compound interest that will accrue will be. But, the credit card companies only advertise the simple rate of interest to you. An example given from The Simple Dollar explains this. If you owe $3,000 on your credit card that has a 24.99 percent interest rate, if you use simple interest, you would owe $749.70 extra in interest after one year. Using monthly-compounded interest, you will owe $3,841.82, or an extra $92.12. If interest is compounded more often than monthly the figure you owe will be higher.

Prevention/Solution

The important lesson is to not carry a balance at all, and then you won't have to worry about interest. The next best thing is to pay more than the minimum balance so that the interest calculations will be lower. If you are putting money in savings, but are carrying a credit card balance, you will be wise to pay off your credit card before putting money in savings. The interest the credit card companies charge you will negate any money you earn in savings.