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Paying only the minimum on any debt will make it go on forever. You can pay down debt much faster with the methods I go over in this post. Did you know that when you pay the minimum on a credit card, it applies your hard-earned money to mostly interest? Even as tempting as it might be, you should try your best to avoid doing this.
The Reason Why
Most credit cards charge between 2% and 4% of the balance as your minimum payment. So for an example we are going to say we have $5,000 at a 22% interest rate.
First, you need to find your interest rate (in our example its 22%).
Second, You convert it to a monthly rate by dividing it by 12. So ours is 22% and the monthly rate would be around 1.83%. (this amount is fixed and the higher the rate, the harder it is to pay debt down)
Third, you multiply it by your balance. Our example of $5,000 would calculate to a monthly interest charge of 91.50. So to find out what the minimum is, lets say its calculated at 3% so our minimum payment would be $150 and we would only be paying off $58.50 of the total balance each month.
Can you see how this would get you nowhere fast? You can pay down debt faster by paying more.
Note: the interest percentage amount each month is fixed but you can change your debt by paying more and there will be less debt for the interest rate to be applied to. 😉
It Makes the Debt Last Longer
So like in our example, paying the minimum for one year would only take the $5,000 balance to $4392.85. At this rate, it would feel like an eternity to get that balance gone.
It only makes a small hole in the very large debt. If you pay extra, you can accelerate the payments. In our example, paying an extra $100 a month would take the debt away in 26 months. Only paying the minimum would take you 5 or more years to pay off.
I can’t image a more motivating way to keep paying than to see that balance drastically decrese.
You can use the payment calculator I found on Credit Karma to calculate what making extra payments will do.
Also, if you have more than one card, you can use what is called a “snow ball debt repayment plan“. Dave Ramsey, who we have probably all heard of at this point, says that this debt reduction stradegy can not only help you pay down debt faster but it helps you see progress as you go.
The short to the snowball method is this:
- List your debts from smallest to largest no matter what the interest rate is
- Make the minimum payments on all but the smallest
- Pay as much as possible on your smallest debt
- Repeat this down the list until everything is gone
So, basically you can set a total amount that you want to throw at your debt. Say you are going to do $500 total. If you have 4 cards and they you pay the smallest balance off, then you would take away that and move on but still use $500 for your total until they are all paid off. You should see the last card disappear pretty quick when you are throwing ALL the $500 at it.
I promise you, it is a wonderful feeling to make progress like this. I have used this method and I loved it.
* I know that we are not all perfect but I just want you to know that there IS hope for your situation.
It Messes with Your Credit Score
Only paying the minimum can mess up your credit score.
See how to raise your credit score here.
About 30% of the FICO score is calculated from what you owe. They don’t like to see high balances on your accounts.
To a lender that looks up your credit score, high balances look like you can’t afford any more debt because you can’t pay back what you already have.
This makes it much harder to borrow money. Let’s say you wanted to buy a house. If your debt to income ratio is higher that 43%, they are not going to be willing to loan you the money or it could greatly reduce that amount you can borrow for your home.
Most lenders prefer for the percentage to be under 36% and only 28% going towards your mortgage payment.
If your income is $5,000 per month, you could only afford a $1,400 per month payment which would be 28%.
Lets say you pay a $350 car payment and $500 for other debts, that would be $2250 total including the mortgage. This would put your debt ratio at 45%. So then they would probably reduce the amount you could borrow or ask you to pay off existing debts before they approve you.
In this housing market, that baby (the dream house) would be gone before you could get approved. See how sad this can be and why it’s better to get that debt tackled!
You end up Paying More Interest
Credit cards can be an expensive way to buy things if you think about what you actually pay after all the interest is calculated. I stopped one day to think about this and it actually made me feel sick. Right then, I decided I wasn’t going to buy things that I couldn’t pay for if I had to use credit.
The only exception is when I make larger purchases and I am offered 0% for a certain amount of time. We did this with our living room furniture and I made sure that I was able to pay it off before the interest was added each month.
We used a 0% deal to buy our tractor and it has worked very well for my family. We always make sure that the purchase is justified and affordable. It was also needed because we have been able to do so many things on our property that we would have had to hire out if we didn’t have it.
The key to credit is to make sure you use it responsibly. The ultimate goal is to not need it but I realize that most of us are working parents that just can’t live without some sort of credit.
How to Pay off the Balances
Start by going over your budget and finding ways to decrease your spending.
Pay more than the minimum whenever possible.
Resist the temptation to buy when you are trying to pay things down.
It is so important to get out of debt and fast, it will make life so much easier.
You can master your money if you can master your debt.