Credit cards can be very useful. They can act as an extra buffer account months when the household economy gets a thorn.
With a credit card, you then have the opportunity to “borrow” on the card instead of applying for a fast loan or a private loan. Credit cards are also excellent to use on the trip as they provide an extra “layer” of consumer protection when making payments. They can also provide benefits in the form of reimbursement, bonus points for air travel and more.
However, credit cards can also be a trap – a very expensive one for that. In some cases, it may therefore be better to borrow instead. Depending on the amount of money you need, apply now and see what interest rate you can get.
If you do not pay your debt in full, a credit will start rolling and it comes with a cost. With minimum payments, over time the credit can cost a lot. Exactly how much we talk about below.
The cost of paying the smallest amount possible
For the majority of credit cards in the Swedish market, a minimum monthly payment of 2-3% or at least USD 200-300 is required. There are differences between different cards, but in the name of honesty they are not very big. The smallest possible amount is what you have to pay monthly for the credit to remain active and for the case (eventually) not to go to debt collection.
With these low amounts for minimum payments, it takes a long time to repay even small debts. For larger purchases, it can take many years to become debt free with the smallest monthly payments.
Example: You buy a new computer with the credit card. The price tag for the computer is USD 13,000. Should you pay USD 200 a month, it will take 65 months before your debt for the computer is paid. It’s been almost five and a half years, and probably the computer is discarded by that point.
With high effective interest rates, costs are rising
In the above example, we do not expect interest rates. We expect it to be even more refined. To give you a clear picture of the effect on the interest rate, we must first tell you how the credit interest rate is calculated in relation to the debt.
The interest rate is calculated according to the following formula:
- Divide the credit interest rate by 360 (days)
- Multiply the result by 30 (days)
- Multiply the result by the current debt.
Example: The credit card you use to buy your computer has a credit interest rate of 16%. If we include that interest rate in the formula, we get the following results:
- (0.16 / 360) = 0.00044
- (0.00044 x 30) = 0.0133
- (0.0133 x 13,000) = $ 173.33
If the minimum amount to pay each month is USD 250, USD 173 will be interest on the first month. This means that your debt will be reduced by only USD 77. The fact that the interest rate is such a large part of the repayment gives rise to very large credit costs in the long term.
Note that here, to simplify, we assume that you normally have an interest-free period of between 30-60 days on your credit card.
The actual cost over time
Actual cost over time with minimum monthly payments is always high. The higher the interest rate and the lower the payment, the more you pay in total.
We continue with the example of the purchase of a computer. If you pay USD 250 a month, you will have to repay the computer over 90 months (7.5 years). The total cost of the credit will be USD 22,500. If the minimum amount instead is USD 200, the repayment period will be 153 months (12.75 years) and the credit cost will be USD 30,600.
What can you do instead?
It is hopefully clear to you now that it is a bad idea to let the credit run month after month.
What you do with the credit card you should pay back as soon as you can. Is just USD 13,000, as in the example with the computer, too much to repay the month after the purchase, the payment may be divided into a couple, three months.
If you need to split the payment over a longer period of time, you should probably consider both once and twice if you really can afford to make the purchase.
An alternative to credit card purchases is of course to buy on installment. However, the same basic principles apply. The same applies to credit loans. You should simply pay back as soon as you can to avoid extra, unnecessary costs.
Let the interest rate work for you
As you can see, interest rates are the big culprit in drama. However, interest is available in two variants, namely cost interest and income interest. With the latter, you can get the interest rate to work for you.
USD 200 or USD 250 a month in savings gives several thousand dollars on the savings account after only a few years. If you also make sure you get some interest on the money, the total grows faster.
USD 250 a month gives a total of USD 3000 per year. After four years of savings with a 1% interest rate, you have USD 12,212 in savings account, that is almost as much as the price tag for the computer. Note here that we have calculated 30% tax on interest income.
A credit card purchase can be very expensive. If you take advantage of the possibility of credit for a long time, there is a risk that the purchase will be twice as expensive as if you had paid cash.
The temptation to split the payment and only pay the smallest monthly payment can be great, and certainly it is convenient to pay maybe USD 200-300 a month, but you are guaranteed a big loss in the long run.