If you have ever used a credit card to make a purchase, you might also know that credit cards are loans. While they may not feel like your standard loan, where you make a set monthly repayment on a set amount borrowed, they are loans nonetheless.
But credit cards differ from standard loans in one important way; the interest charged ‘compounds’. In other words, when you do not pay off the credit card balance in full each month, you will pay interest on top of interest. So easy to charge.
This is how credit cards really work: Say you purchase a new TV for €800. If you use your credit card to pay for the TV, you’ll have a few options to repay the €800: 1. You can pay off the full balance on the credit card when the bill arrives, or 2. You can make regular monthly repayments.
It is estimated that here in Ireland, roughly half of families do not pay off their credit cards in full each month. Of those that don’t, many make only the MINIMUM PAYMENT. It’s the minimum payment that makes the cost of the TV really interesting. Here is why.
On a TV costing €800, let’s say the rate of interest on the credit card is 18% (this would be fairly typical here in Ireland). Also, many credit card banks have a set ‘minimum payment threshold’, this could be 2.5% of the balance and a set amount of money also. So, the family that purchased the TV will have to pay off the balance owed but each month that a balance is outstanding, they will have to pay interest too. And this interest keeps adding up, it keeps getting added to the outstanding balance. It’s a bit like taking 2 steps forward and 1 step back!
In the first month after they purchased their TV, the ‘minimum’ payment will be 2.5% of the €800 which works out at €20. If the family makes the €20 minimum payment, one might feel the outstanding balance would reduce by €20, but that is not the case. Interest is then added back onto the remaining balance and since the rate of interest charged is 18%, this is added onto the credit card balance; in this case, €11.70 is added back on. This means the credit card balance only reduced by a paltry €8.30.
So, next month’s credit card bill will not be for €780, instead, it will be for €791.70. You see how this is shaping up, this is the cycle of credit card debt and it can be so hard to shake.
The true cost of that €800 TV.
In the end, that lovely €800 TV costs a lot more and takes a lot longer to repay. How much and how long I hear you ask? Well, here is the final breakdown. It will take anywhere from 7 – 10 years to repay and the total amount repaid will range between €1,500 - €1,800 in total repayments (original debt plus interest).
One thing to note is the ‘minimum payment’ required by your credit card provider will determine how long and how much it will take to repay the original balance. Paying off credit card debt can save you a bundle by way of lower interest charges. The Central Bank of Ireland cautions that in some situations, debt consolidation loans that take longer to pay off than previous loans can incur higher interest charges.
Here at St. Joseph's Irish Airports & Aviation Credit Union, we recommend members repay their credit card debts as quickly as possible if they want to avoid the more expensive alternatives of high interest charges over the full term of repayment. But we know this can be easier said than done which is why we offer members the option to ‘consolidate’ credit card debt into one simple repayment option. This can slash the cost of interest and also reduce the time it takes to repay the balance.
We work hard to help our members reduce the cost of borrowing. And in the weeks where credit card bills are coming due, we provide members with low-cost options to slash the cost of credit card debt. In the meantime, if you can increase the amount you repay on your credit card by just a little over the minimum payment, this can speed up how soon you will clear the €800 balance (assuming you made no additional charges) and the cost of interest paid. For loan repayment options, use our easy-to-use loan repayment calculator HERE