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How much does credit card debt cost you?

How a $3,000 purchase can turn into one that costs you $6,641.

By MSN Money Partner Mar 2, 2011 9:24AM

This post comes from Debbie Dragon at partner blog Wise Bread.

 

Credit cards sometimes make a purchase hard to pass up. For example, they make it possible to buy something for $3,000 and pay just $60 per month until it's paid off.

 

Most people can afford a $60 monthly payment, but what is often overlooked is how much you end up paying in interest. A common mistake people who are new to credit cards often make is paying just the minimum payment on their credit card bills. The small monthly minimum payments seem insignificant and comfortable in most budgets until you look closer at what your credit card debt is really costing you over time.

 

How to calculate true credit card debt costs

If you carry an average daily balance of $3,000 in credit card debt, your minimum payment will be about $60 a month (assuming a 2% minimum payment requirement -- but some cards may have a different minimum percentage). If the credit card charges a 15% APR, interest could cost you between $400 and $450 per year.

 

Here's how to figure it out:

  1. Divide your APR by 365 days per year: 15% / 365 = (about) 0.04%
  2. Multiply 0.04% by 30 days per month: 0.04% x 30 = 1.2%, or 0.012.
  3. Multiply 0.012 by the $3,000 original balance = $36 a month in interest. 

With a $60 minimum payment, $36 goes toward interest each month and $24 goes toward your $3,000 credit card balance. So after you send your first $60 payment on your $3,000 credit card bill, you will still owe $2,976.

 

If you pay only your minimum balance due each month (the higher of 2% or $25), it will take approximately 16 years to pay off your $3,000 debt. During those 16 years of making the minimum payments, you will have paid $3,641 in interest, turning your $3,000 purchase into a $6,641 one, according to results from a minimum payment calculator on CreditCards.com. Whatever you purchased for $3,000 will likely be broken and forgotten long before you've paid for it in full.

Avoid becoming a credit card victim

Credit cards are important in our lives -- you need one to reserve a hotel room, rent a car, or book tickets for travel. They can provide a source of emergency funds if you've been injured or have another emergency that must be paid for right away.

But you want to get into the habit of paying for your credit card debt in full each month as often as possible to avoid paying interest -- or at least pay as much as you can toward any credit card debt to reduce the amount of interest you pay rather than making just the minimum payment.

 

How to reduce your current credit card debt

If you've already racked up debt on a credit card or two and want to avoid paying the credit card company large amounts of interest, you'll want to become proactive in paying off your credit card balances.

 

Start by creating a budget that allows you to allocate as much money as possible to credit card debts, rather than sending just a minimum payment to each account every month. Get a debt-management plan in place.

You should also take a look at balance-transfer credit cards. If you are eligible for a card with a 0% interest promotional offer for balance transfers, you can move your higher-interest credit card balances to the lower-interest card and focus on paying off your debt. Since you won't be charged interest during the promotional period, all of your monthly payments will be applied toward the principal balance, which will help you pay your debt off faster.

 

Finally, if you find you are barely able to pay just your minimum credit card payments, you should contact the National Foundation for Credit Counseling for advice.

 

More from Wise Bread and MSN Money:

1Comment
Mar 2, 2011 9:37AM
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There are also free online tools that help you put a debt payoff plan in strategy so you no longer have to worry about what to payoff first, or what is worth transferring. Balance transfer offers that are actually worthwhile will also soon be a thing of the past, according to latest research.
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