The Cost of Credit Card Debt

You've probably heard by now that credit card debt is as good for your finances as cigarettes and syphilis are for your health. In my opinion, if you're in credit card debt but refuse to assess its damage to your finances because you're afraid of what the numbers will look like, you're behaving no differently than someone who knows they're unhealthy, yet refuses to visit the doctor because they're afraid of the diagnosis. I've crunched a few what-if scenarios for those of you that may have credit card debt and are paying the minimum balances. Yes, this is meant to scare you.

First, let me explain assumptions I used to calculate my numbers:

• Credit card minimum payments vary over time; the higher your balance, the higher your minimum payment. They're equal to the current month's interest plus 1% of the principal. Usually, there is a minimum minimum payment, typically $20. This means that if your balance plus month's interest is less than $20, your minimum payment will be $20.
• Your first minimum payment will be the highest. Minimum payments will get smaller as time goes on because your balance will go down.
• If you can afford the first (and highest) minimum payment, you should be able to afford it every month if you choose to accelerate the credit card's payoff.
  
• You would be able to afford to put the amount of your first (and highest) minimum payment into a savings account if you did not have credit card debt.
• I assume 5% earnings in a savings account if money was saved versus paid to credit card
• I assume a 28% tax bracket
• I assume a $20 minimum minimum payment

Definition of savings terms:

• Savings account balance: variable contribution: This is what the savings account balance would be if the credit card's minimum payment each month was saved for the length it would take to pay off the credit card with a minimum monthly payment. Because of the shrinking credit balance, this assumes a decreasing monthly savings amount.
• Savings account balance: variable contribution: This is what the savings account balance would be if the first (and highest) credit card minimum payment was saved each month for the amount of time it would take to pay off the credit card with minimum monthly payments. This draws upon the assumption that if you could afford to pay the first minimum payment once, you could afford it every month.
  

Here are my scenarios:

• Credit card debt: $8,000
  Interest rate on debt: 15%
  Initial minimum payment: $180
  Months to pay off debt with minimum monthly payment (decreases over time): 283 (23.5 years)
  Total amount paid to credit card company: $17,300
  Total interest paid on balance: $9,300
  Potential savings account balance: variable contribution: $41,000 ($34,375 post-tax)
  Potential savings account balance: fixed contribution: $96,900 ($84,000 post-tax)
  
  Note the difference in slopes from the CC payoff (pink line) and the two potential savings growths (black and blue lines)
  
  
  
  
• Credit card debt: $3,000
  Interest rate on debt: 30%
  Months to pay off debt with minimum monthly payment (decreases over time): 215 (17.9 years)
  Total amount paid to credit card company: $9,520
  Total interest paid on balance: $6,520
  Savings account balance: variable contribution: $17,564 ($15,312 post-tax)
  Savings account balance: fixed contribution: $36,400 ($32,530 post-tax)
  
  
  Note that even with a smaller balance, with a high interest rate on a credit card, it still takes years and years and thousands of dollars of interest to pay it off with the minimum monthly payment
  

Now let's see what would happen with these same balances after making some sacrifices and putting more than the minimum payment to the card every month:

• Current credit card debt: $8,000
  Current interest rate on debt: 15%
  Original minimum monthly payment: $180
  New monthly payment: $500
  Months to pay off debt with new monthly payment: 18 (1.5 years)
  Total amount paid to credit card company: $8,981
  Total interest paid on balance: $981
  Total interest payment savings vs. minimum monthly payment: $8,319
  
  
  Note that by scraping together an extra $320 for a year and a half, you save yourself $8,319! If you were only able to scrape together an extra $100 per month and pay $280 per month, you would still save about $7,350 in interest.
  
  
  
• Current credit card debt: $3,000
  Current interest rate on debt: 30%
  Original minimum monthly payment: $105
  New monthly payment: $255
  Months to pay off debt with new monthly payment: 14 (1.2 years)
  Total amount paid to credit card company: $3,825
  Total interest paid on balance: $825
  Total interest payment savings vs. minimum monthly payment: $5,690
  
  
  Note that by scraping together an extra $150 for 14 months, you save yourself $5,690! If you were only able to scrape together an extra $75 and pay $180 per month, you would still save about $5,585 in interest. And again, if you could only scrape together an extra $20 per month, you would still save yourself $4,877 in interest!
  

As you can see, even putting a little bit extra toward your credit card balance goes a long way. A way to look at credit card debt is this: If you have a credit card on which you carry a balance and pay 15% interest, you're paying 15% on everything that you buy, even if you're not putting it on a credit card. That's because that every penny that you spend while you're carrying a balance could have gone toward paying off the balance.

If you have credit card debt and are paying the minimum payment each month, sending any extra that you can afford -- even if it's only $20 -- will result in incredible long-term savings.