Making Cents: Three ways to pay off credit cards
I CAME across a study recently which discovered that about two thirds of Irish people don’t know how much interest is being charged on their credit card.
Which is fine if you clear the amount owing every month, because you’re not being charged anything but if you’re carrying an outstanding balance every month, I’d say familiarise yourself with the rate and do so fairly quickly.
Because the rate could be as much as 23%.
The danger with such a high interest rate is that if you are carrying a debt of say €2,500 and you pay 2% of the balance outstanding each month i.e. €50 (the minimum % you are allowed to pay varies between providers and is typically between 1% and 3%), it will take you nine years 10 months before you see your debt cleared off in full, and in the meantime you’d end up paying about €3,361 in interest payments.
And in fairness, it can be hard to figure out what €2,500 at a rate of say 22.90% with minimum monthly repayments of €50 will end up costing, but it’s not difficult if you spend five minutes googling credit card calculator and insert the numbers. The answer will appear in a couple of seconds.
Anyway, in that same survey I referred to, about 20% of people will only make the minimum repayment each month and 9% won’t even do that, which means they are carrying balances that are reducing at an incredibly slow pace.
The reason for this is how interest is being applied to how much you owe and the rate of interest has a huge impact on this.
Let me explain and let me show you how interest is calculated each month.
Whatever your credit card interest rate is, divide it by the number of days in a year i.e. 365 – 22.90%/365 = .06%
Multiply your answer by the number of days in the month e.g. .06% x 30 = 1.80
Multiply this number by the balance on your card and that is the amount of interest you pay each month e.g. €2,500 x 1.80% = €45.00
In this instance if you’re making a monthly payment of €50, only €5 is coming off the amount you owe which is the reason why it will take you nearly a decade to pay it off in full.
So, in this example 10% is going to reduce the balance and 90% towards interest payments.
And that’s what the credit companies want you to do, because you end up paying them back a fortune in interest payments. In the example I just showed, by the time you clear the debt with your €50 per month, the credit card provider has made 134% from you. Great return for them, awful for you.
This is something that is often overlooked by people with credit card debt.
They only focus on the small minimum payment they make each month and ignore the much larger amount they pay in interest, but perhaps if they knew or took more notice of what % of their minimum payment was coming off the amount they owe and how much they’ll end of paying back in interest, they’d do something about it, if they could that is.
And what can they do?
I believe they have three options.
Transfer to 0% providers
There are still some credit card companies in Ireland who offer 0% interest when you transfer your balance to them. These offers are typically for new customers only and they allow you to transfer your existing credit card balance and pay 0% on it for six or seven months.
This is an excellent way of helping you pay down the amount you owe faster because you know for those six or seven months, all of the amount you pay is coming off the capital, and nothing is going towards interest.
Take out a term loan
If you could replace a credit card debt with a term loan i.e. you take out a term loan and use it to repay your credit card debt, you will repay it faster and reduce your interest payments significantly.
For example, if you borrowed €2,500 at a rate of 5.99% APR (this rate is available from Revolut), over a five year term, your monthly repayments would be circa €48.12 and the interest paid back in full, assuming the rate remained the same, €387.
When you stand this repayment against the credit card, it’s a bit of a no brainer.
Credit Card: €50 per month = nine years 10 months to pay back in full, and €3,361 in interest payments.
Term Loan: €48 per month = five years zero months to pay back in full, and €387 in interest payments.
Pay more than the minimum due
Sticking with that same example i.e. €2,500 owed at 22.90%, if you paid €75 per month rather than €50, you’d accelerate the repayment and have the debt cleared in four years three months and you’d end up paying €1,263 in interest payments.
So, that extra €25 each month which mightn’t seem like a whole lot, actually reduces the term by 67 months and it would save you €2,098 in interest payments.
And that’s easier said than done as well.
Trying to find an extra €25 for some people might be a very big ask, but you’ll only ever know if you have a monthly budget in place.
Knowing what areas in your monthly outgoings where you might be able to make adjustments is important. If you can find them and you can redirect that €25 to your minimum repayment each month, the impact as you can see is excellent. And breaking down that amount to €0.82 cent per day, might make it easier to find, maybe.
And there is one other way you can avoid building up a debt on your credit card and that’s by choosing the option whereby the full amount spent using the card is debited from your savings or current account each month.
Having your monthly direct debit set up this way, will make sure you never forget to pay the full amount outstanding and it will also make you think twice about buying things that perhaps you don’t need or want, knowing you are going to pay for them in full the following month and not spread out over a longer period of time.
And if you take away anything from reading this article, I hope it’s two things.
The first is to pay more than the minimum amount each month. Don’t get suckered into paying it because that’s exactly what your credit card provider wants you to, because if you do they will be on your payroll for years and years.
And secondly, once you understand and know how the interest rate is charged on a credit card balance and how much of your money is going in interest, it may motivate you to look at those three alternatives I outlined, because they will help you pay that outstanding balance off faster.
And to those who aren’t carrying any balance on their cards, I’m hoping that after you’ve read this, you’ll keep it that way.
Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at [email protected] or www.harmonics.ie