It's nice of your credit card company to give you the option to pay off your balance over time with small, minimum monthly payments. However, while this option does give you flexibility, it's mostly designed to keep you in debt.
Photo by openDemocracy.
A while back, I noticed a popular issuer actually listed "the ability to pay off your balance over time" as a perk to using their credit card. Nice spin, but this is less of a customer benefit than it is a business model. Your revolving balance earns interest, which is how credit card companies make money. The truth is minimum payments are designed to keep you in debt.
According to ASIC's MoneySmart, a government-run website that provides money advice to consumers:
"If you have $4400 of credit card debt and only make the minimum repayments, it will take you 31 years to pay it off and cost you around $14,900 in interest. But if you pay off $216 each month you'd pay off your debt in two years and save $9700 in interest."
The average card holder is paying around $700 in interest per year if their interest rate is between 15% to 20%.
Most consumers already know this: credit card companies prefer customers who revolve a balance because those customers are more profitable. As financial services consultant Andrew Kahr explained:
"...it is the cardholders who revolve, who use the debt, who pay finance charges, who contribute, cover the overhead, provide some profit for the lender. So someone who always pays in full in 30 days, 45 days, doesn't incur any charges of any kind, has the card for free, the bank does get some income from that because of the way the clearing relationship with a MasterCard and Visa is structured...but it's not enough to cover the costs, or not more than very barely...The profit is made by lending."
On the other hand, none of this matters if you pay your credit card balance in full and on time, which you should try to do anyway to avoid interest and fees. Also, relaying this info isn't about blaming the credit card companies. A lower minimum balance can help consumers in times of financial stress, after all.
However, if you're revolving a balance every month, it's more useful to see this flexible "perk" for what it truly is: a plan to keep you in debt.
MoneySmart has outlined some basic steps to help you pay off your credit card:
- Stop adding more debt to your credit card
- Pay more than the minimum repayment - even an extra $50 per month will make a big difference
- Set up a direct debit to pay a fixed amount off your credit card balance each payday
- If you have more than one card, pay off the one with the highest interest rate first or tackle the one with the smallest debt first