The Shocking Pop Quiz
Here’s a pop quiz to test your credit IQ.
- You cut up your credit cards on your 26th birthday.
- Owing $3,000 at an APR of 20%, you pay your 2% minimum.
- You’re never late.
- How much will it cost you to pay off your $3,000 debt?
$16,000! And you’ll be 80 years old.
To turn a phrase, paying minimums is a maximum problem.
A Warning Missed
Every month, on every credit card statement, there is a ringing credit alarm for you to hear – if you know how to listen. If the amount you pay equals the amount suggested by the card issuer, you should be hearing that alarm. Like one of those code blue emergencies you see on television shows set in hospitals, you should imagine doctors in hospital scrubs running to your aid as your write that check paying only the minimum. You are dying financially, one minimum payment at a time.
Economics and business professors, accountant and a lawyer here and there (usually bankruptcy lawyers) know the right answer to the pop quiz. The typical wrong answer is somewhere between five and ten years. Most people think that they can retire their debt in a reasonable time frame. They rarely do the math.
Know Your Debt Burden
Right now go and gather your most recent credit card statements. Try to guess your APR. Do you even know what an APR is? Most consumers do not. It is the interest rate your bank charges you on your credit card. If you have really good credit or have recently gotten the card on a promotion it may be a low as 0%. The national average, however, is between 13% and 14%. This calculator at Banrate.com has a default setting of 18% because most consumers who want to figure out “the cost of paying minimums” are realizing that they are paying and paying and paying every month and there debt is not diminishing.
This calculator will tell you exactly how long it will take you to pay off your credit cards if you cut them up today, never use them again and only pay the minimums. Once you catch your breath at realizing you may never be able to get out of debt in your lifetime at your current income, it is time to take action.
How to Escape Life Long Minimum Payments
There is no magic formula. The Federal Reserve, Federal Deposit Insurance Corporation (FDIC) and Office of the Comptroller of the Currency (OCC) and the Office of Thrift Manage adjusted the regulatory floor for minimums from 2% to 4%. Although this regulation was passed in 2005, it has yet to be fully deployed because consumers who habitually pay only minimum do so because that is all they can pay. If you can manage to pay the 4% minimum, essentially double what you credit card statement suggests, you will likely be able to get out of debt in a reasonable amount of time. If you want to know how long, use the calculator at Bankrate.com mentioned earlier. Otherwise, you may find yourself paying off that spring break vacation to Fort Lauderdale in 1981 with your Social Security checks.
