How credit cards are destroying you financially
/Let's talk Credit Cards.
Banks absolutely love them. Owners of banks adore them. Why?
Because credit cards are the "single most profitable product" for banks.
They are much MUCH more profitable than housing loans, car loans, personal loans, or whatever loan you can think of.
Why? 3 reasons:
1. Exorbitantly high interest rates!
2. Late payment charges!
3. Financially "not smart" people always keep their credit card balance high!
1. Interest rates
Interest rates on credit cards are (on average) 400% HIGHER than an equivalent interest rate on (for example) a personal loan. Yes, 400% higher!
Let's say you take a personal loan of $10,000.
Let's say the interest rate on that personal loan is 5%.
This means you're paying $500 per year as interest.
This means you're paying $42 per month as interest.
AND: when you take any kind of loan, you'll be paying the interest monthly but also part of the principle (the loan itself), so over time, your balance goes down, and therefore your interest cost goes down. More on that later.
Let's compare this to you racking up the same amount ($10,000) on a credit card.
Interest rate on a typical credit card is around 20%.
This means you're paying $2000 per year as interest.
This means you're paying $167 per month as interest.
That's FOUR TIMES what you would pay on a personal loan!
2. Late payment charges
Not only that: unless you have given your bank instructions to AUTOMATICALLY debit your monthly credit card bill, you will often forget for a few days.
Banks LOVE that: they charge you a LATE PAYMENT fee every time you're a few days late in making these payments. These can be as high as the interest, so basically (for our example) around $100 per month.
This means that EVERY SINGLE MONTH: YOU ARE PAYING $267 TO THE BANK AND GETTING NOTHING IN RETURN. YOU ARE LITERALLY "BURNING" $267 EVERY SINGLE MONTH!
And what do you get for paying $267 every month? Nothing.
3. Credit Card Balances
This is another customer behaviour banks know and love:
If you have a housing loan, a personal loan, a car loan (etc), your monthly bill to the bank consists of 2 components:
- Interest on the balance
- Part of the principle (the loan)
This means that the balance is dropping every month, because you're paying part of the loan every month.
And since the Interest is calculated on the "balance" (e.g. 5% on $10,000), your monthly interest cost will drop every month as the balance drops.
HOWEVER: most people only pay the "minimum amount" on their monthly credit card bill.
When you pay the "minimum", your Balance remains the same! So this means that the bank is charging you Interest on the FULL BALANCE every month. It NEVER goes down!
SO WHAT TO DO?
This doesn't mean "never use" credit cards. Many offer fantastic benefits (air miles, cash back, discounts, etc).
What I do is: I use them ALL THE TIME, but I pay my balance down to ZERO every month. So I NEVER pay interest, ever. It's always ZERO.
So I get all the benefits without the cost (except the one-time annual cost of the card itself).
Banks hate that. They don't make money from people like me.
They make money from people who keep their balances high and keep "burning" money every single month: interest and late charges.
If you already have a high credit card balance and can't pay it down to zero: many banks will accept to convert it to a personal loan for you, and if they don't, take a personal loan and use the money to pay your credit card down to ZERO.
But your first attempt should still be: do everything you can to pay it down to 0.
Be smart, don't let them banks fool you.
