The True Cost of Credit Card Debt

How Much Credit Really Costs

If you pay off your credit card balance when it comes due each month and use a card with no annual fee, credit is costing you nothing, while giving you use of your money for the 25 days or so grace period.

But what if you are one of the countless millions who do carry a balance? What is the true cost of your credit?

How Credit Card Payments Are Applied

Let’s take two different scenarios and try to figure it out. These are only rough approximations and assume there are no other fees or penalties assessed on you account.

You have a couple of credit cards and, being a responsible consumer, you only use part of the credit line. So out of a $7500 limit you are only carrying a balance of $3000. Because you have a pretty good credit score your rate of interest is only12.99%.

You are walking through your local mall and see the must beautiful, fuzzy green, purple and gold widget you have ever laid eyes on – and even better it’s half off – only $100. Since you don’t have that much cash available, you whip out the plastic and buy it.

Now you know all about the cost of credit and in order to minimize it, you pay $100 a month rather than the $35 minimum. But did you know that your latest charge will not be paid until the outstanding balance is paid?

In other words, the little booklet you got with your card says something to the effect that payments are applied first to the lowest APR debt and then to the oldest debts. You last hundred dollar charge is at the end of the line.

Now these next calculations are more approximations than anything else, since I don’t have the mathematical knowledge to figure this out exactly nor access to the specific formula the bank will be using. But it will give you an idea of how much your widget actually cost.

These calculations also assume you keeping charging, maintaining your balance at around $3000.

If you pay down the $3000 balance at $100 a month, you widget will be next in line in about three years. While sitting in line it roughly will run up $38.70 in interest charges. It will take a little over a month to pay off, running up another $1.10 in interest. So the actual cost of your widget is $139.80.

Now if you are not so frugal and just pay the minimum, it will take almost 20 years for your widget to get to the head of the line. By that time it will have run up interest charges of about $258. It will take another three months to pay off, for another $2.14. So this widget, which is now likely residing in some landfill, will have cost you about $360.

These calculations don’t take into account the lost use of your money – that paid for the item and the interest charges - which would make your widget even more expensive.

If you’re naughty and go over your credit limit or make your payment late, who knows what it will end up costing. Those $39 fees add up quickly and earn the bank interest like everything else.

Other Credit Card Fees

There are other charges that you should know about, but maybe don’t. For example, if you go outside of the states on vacation, you will likely be charged a currency conversion charge, usually 2% of the total amount charged.

If you take a cash advance whether by check or through an ATM machine you will pay about 3% of the amount borrowed, sometimes with an upper limit of $99, other times with no such limit. And interest starts running immediately, usually at a higher rate than charged for purchases. There are no grace periods on cash advances.

Then there is the so-called “two cycle billing period.” You’ve just inherited $100,000 from a rich uncle and want to pay off your credit cards. You send in a check for the full balance, but lo and behold, you get yet another bill next month for interest on the debt you already paid. And if you take too much time paying that, you’ll be starting a new balance all over again.

And watch out for the deadly universal default clause. With this handy clause, when you pay your electric bill late, the lender has the ability to jack your interest rate to about 30%, although you’ve always been on your best behavior with him.

What is the answer to this madness? Don’t charge unless you can pay the balance before the grace period ends. Better yet, don't buy depreciating assests on credit.

Impossible you say. But about 45% of Americans don’t even carry a credit card.

Maybe you can’t buy everything you want on a whim, but in the long run you’ll be better off.

If you want a consumer friendly credit card, consider a Pulaski Bank Gold Visa. A top consumer magazine considers Pulaski one of the top 10 Consumer Friendly credit card issuers in the US, mainly because they avoid a lot of these tricks.

Credit Card Regulations Set to Change

Federal administrative agenices have created new rules that will affect how payments are to be credited. Unless Congress acts sooner, in July 2010, lenders will not be able to apply payments only to the lowest interest rates.

So, if you have taken advantage of a low or zero APR offer, your entire payment will not be applied solely to your balance associated with that offer.

Read more about the New Credit Card Regulations here.

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