Credit Card Interest: How Does It Really Work?
According to recent data from the Federal Reserve Bank of New York, Americans currently owe a total of $930 billion in credit card debt. That is $46 billion more than last quarter and $57 billion more than this time last year. Whenever credit card debt rises, either collectively or individually, it’s often a bad sign that people are taking on debt that is going to be difficult to eliminate in the long term.
CNBC published a report in 2018 that stated that it takes a household approximately 13 months to pay down credit card debt of $8,200, and that’s only if that household aggressively earmarks 15 percent of its income to paying that debt. In many cases and depending on several circumstances, it can take years for people to pay off their credit card debt. Why is this happening? Three words: credit card interest.
Credit card interest is something that costs Americans billions of dollars annually, yet far too many people are unfamiliar with how it works and why, despite paying their credit card bills every month short of the full balance, people remain in debt and wind up owing more debt. We’re going to dig into that issue below in hopes that you’ll obtain a deeper understanding of why getting out of consumer debt as soon as possible is one of the best things you can do for your long-term financial wellbeing.
The Nature of Compound Interest
When you obtain a credit card and you make a purchase, your credit card agreement states that you’re going to pay that credit card company back. Some cards require full payment every month, but most allow you to pay back your debt over time as long as you make minimum monthly payments. However, when you take more than one payment period to pay off the balance of your loan, credit card interest comes into play. That means you’ll be paying back the amount you originally borrowed or did not pay during the grace period, which is known as the principal, along with additional charges known as interest.
Interest is how credit card companies make money from their cardholders. These companies like it when borrowers do not pay back the full amount borrowed in any given period. That’s because someone who originally “borrowed” $100 to buy something will be paying more than that to eliminate the debt if it takes more than, say, 30 days to do so.
Not only will you be paying credit card interest on your account, but you’ll be paying compound interest. What is compound interest? Compound interest is the idea that your interest rate is calculated based on the total amount that you owe at a certain time, and not on the amount you either originally borrowed or owe on the principal.
APR Is Not What It Seems
When you open a credit card account, you’re most likely going to see literature referring to “APR.” APR stands for Annual Percentage Rate, and APRs can vary widely. Some credit card offers come with an “introductory” APR that’s either very low or even nonexistent, but only for a certain period of time.
Overall in the United States, the average APR on all credit card accounts is approximately 21 percent. Therefore, it would stand to reason that if a person had an account with an average APR, he or she would pay back 21 percent interest on the amount finances over the course of a year.
However, that’s not really how it works. Credit card companies do not compound a cardholder’s interest amount annually, but instead they compound it daily. Obviously amounts and details matter, but how this all plays out is that a cardholder winds up paying potentially much more than that 21 percent in APR over the course of a year.
This is just one of this “items” often found in the fine print of a credit card agreement. Over time, this method of compounding interest is a tremendous advantage for a credit card company, assuming the cardholder continues to make payments over time. This is how seemingly manageable credit card debts can linger for years, and how larger credit card debts can spiral out of control even if a cardholder is making timely but small payments.
Get Control of Your Credit Card Interest
The bottom line is that people who are carrying credit card debt are not only paying interest on what they originally borrowed, but they’re also paying interest on the interest that has accrued to that point. For a lot of people, this is simply not a sustainable financial model, and it’s certainly not an approach that leads to financial independence.
We can help you with that. We offer several different resources and strategies that will allow you to work your way through credit card interest payments and the like so that you can start saving more of the money you work so hard to earn. It’s time to stop paying interest on your interest. Contact us today to learn more about how we can help you. We’ll fill you in on how to deal with your debt so that you’re not spending years paying credit card interest on top of interest. There is a way out from under almost any financial situation, and it all starts with an assessment of where you stand.
Get started today with Wade Torkelson’s insight.
