Yes, we know that you always pay your credit card bill off in full and on time. But there are many millions of people out there who use their credit cards to finance purchases and pay down their bill over time.
According to Equifax, high outstanding debt accounts for 30% of your credit score. That’s why it helps to know exactly what sort of interest you’ll have racked up by the time you finish paying for the purchase.
None of this is to say that you should not use a credit card, especially since credit cards offer significantly more consumer protections than debit cards or cash. It’s just a suggestion to be mindful of the true cost of a purchase before you swipe your card at the register or enter your info online.
There are any number of credit card interest calculators out there. Your card’s website may even have one you can use. For the sake of this post, we’ll use the calculator at CardHub.com.
It’s pretty simple, just enter the total amount you expect to put on your credit card, then the interest rate and then decide whether you want to figure out how long it will take you to pay down the debt making equal monthly payments, or what you’d need to pay each month to pay off the debt within a certain number of months.
So say you plan on charging $900 to your credit card this weekend when you do all your holiday shopping. Figuring an APR of 14% (which is about the current national average) and a monthly payment of $250, it’s going to take you 4 months to pay off that debt, during which you will have paid around $25 in interest, making the true cost of your purchase $925.
But if you decide that you’ll need six months to pay off the $900, you’ll see that though your monthly payments drop by nearly $100, in the end the true cost of your purchase is $937.
If you really stretch it out and pay the minimum — let’s say $70/month for this example — it will take you 15 months to pay off the purchase and will the true cost of your holiday shopping will be $981.
And keep in mind, this example assumes you aren’t already carrying a balance on your credit card. If you have a balance already on your card, the picture gets hairier.
Say you’ve currently got a balance of $800 on your card and then add the $900 in holiday purchases on top of that.
If you make that $250/month payment, yes you’ll pay off the purchase in 4 months and still only rack up $25 in interest on that purchase. But you’ll be accruing an additional $20 of interest on the current balance, which would still need to be paid off. In order to zero out your account with $250 month payments, you would need 8 months and end up paying a total of $82 in interest.
Meanwhile, if you want to pay off your entire account within 6 months, your payments increase to $295/month and you’ll still have paid $70 in interest.