We have all heard of stories of people getting into credit card debt because they overspend and choose only to pay the minimum monthly payment. This can result in a huge debt burden that can affect your immediate future.
Here is an example of some credit card debt scenarios that can make us pay much more than we need to, or worse, get us to owe money to the bank indefinitely.
Purchase a $10,000 TV and only paying the minimum monthly payment
As long as we pay the monthly minimum payment, the bank will not hound us on our debt obligation.
However, simply paying the monthly minimum amount required on our credit card statement is going to cost us quite a fair bit of interest. In fact, let’s work out how long you need to pay before you can clear your credit card debt.
Let us look at John; he is a young professional aged 25, just entered the workforce after studying for years. The first thing that caught his eye was the latest SamSong (unreal brand) Organic Light Emitting Diodes (OLED) television.
Despite just earning $3,400, he was adamant to get the $10,000 SamSong OLED TV. With little cash on him, he decided to use his credit card to make the payment. The bank that issued him the credit card gave him 4x his monthly salary credit limit, this sums to $13,600.
John went home that day a very happy man, with his new toy to entertain himself and his friends.
John decided to not spend another cent on his credit card but only intends to pay the minimum monthly payment. The interest on the credit card is 24% per annum, with monthly minimum payment of 5% of outstanding balance or $50, which every higher.
John will take about 8.5 years in order to pay off the $10,000 SamSong OLED TV. He would be 33.5 years old when he finally finished paying for his TV. Furthermore, he would have paid a total of $6,290 of interest across the 8 years. This is 63% more than what he had originally borrowed.
Here’s a simple table of how long and how much you are required to pay the banks if you were to make only minimum monthly payment for your purchases.
Looks pretty gloomy right?
Purchase a $10,000 TV; spend an extra $100 on his credit card monthly and only paying the minimum monthly payment.
John decided to continue spending just an extra $100 each month on his credit card after the 1-time of splurge of $10,000. Once again, he only pays back the minimum Nonetheless, he still decides to pay only the minimum monthly payment back.
John will forever be in debt. Unlike Scenario 1, where the monthly minimum sum would be enough to pay down the interest and reduce the principal amount, this no longer is the case. Paying the monthly minimum sum would no longer be enough to cover both the monthly spending and interest cost while at the same time reducing the debt.
This means that he will forever be in debt if he decides not to reduce the principal.
So what are the good things about credit cards?
Credit cards can be very powerful when we use it wisely
(1) Earn interest on money that we spent
John can earn one month’s of interest from his $10,000 TV purchase, which amounts to about $21 (for OCBC 360, at 2.25% per annum) for that month. This $21 is earned with no effort, other than charging the purchase to the credit card.
Now imagine that every month, we would accrue some expenditure on our credit card, while our cash is generating interest. Compound it by multiple months and you will be able to see the prowess of the interest earned by using credit card over cash.
Assuming that the card John uses has a 3% rebate, the TV would cost $9,700 instead of $10,000, saving him $300. That’s about 30 lunch meals he can have with the $300 saved.
(3) Earn extra interest on deposits
Some banks have created deposit accounts (OCBC 360 and UOB One Account) that would pay us extra interest if we were to spend above a certain amount ($600 and $500 respectively) on our credit cards.
We do not advocate spending above our means, yet there are always ways to mitigate this spending. We could volunteer to pick up the bill with our credit card and collect cash during a group meal.
Credit cards are a bestowed power that needs to be wielded wisely. The old saying by Benjamin Parker, with great power comes great responsibility. This responsibility we have is not to fall into a spiraling debt scenario.
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