Personal Debt is a bad headache for peoples
Millions of Americans are struggling with credit card debt and it’s leading to serious budget challenges and life delays. But why are credit card balances so difficult to pay off? And how can you overcome the challenges to take control of your finances?
Credit cards are revolving debt, which is harder to manage
There are two basic types of debt: installment and revolving. Installment debts are loans, where you take out a certain amount of money that you pay back with fixed payments. By contrast, credit cards are considered revolving debt, because the amount you owe changes over time. The more you charge, the higher your required monthly payment.
This type of open credit line is convenient because it gives you flexible purchasing power. But it can be hard to manage within your budget. If you overcharge, the bills can be tough to pay. And it doesn’t help that your creditor often just increases your credit limit, giving you more room to charge.
Credit card interest rates are also high
Another challenge with a credit card is their relatively very high interest rates. On average in 2017, credit card interest rates were between 15 to 16 percent, depending on the type of card. That’s high compared to traditional loans that tend to have rates less than 10 percent. And if you have reward credit cards, your rates are probably close to 20 percent. Such high APR makes it difficult to pay off credit debt. It essentially eats up over half of each minimum payment you make.
Let’s say you have a credit card at 15% APR with a 2% minimum payment schedule. Your balance is $1,000, so the minimum payment requirement is $20. However, out of that amount, $12.50 goes to cover accrued monthly interest charges. You only pay $7.50 of the principal debt that you owe.
This gets worse the higher your rates go. If you have rates over 20% APR, then over two thirds’ of every payment you make covers interest charges. As a result, it takes a long time and a lot of money to eliminate this revolving debt.
“Minimum payments are not designed for you to get out of debt fast “
People often assume that creditors set minimum payment schedules to help you effectively manage debt. But those schedules are designed to generate revenue for the credit card companies. The longer you stay in debt, the more profit they earn. So, they’re quite happy if you stay in debt forever as long as your account stays current. But while that’s good for creditors, it’s bad for you.
This means that to effectively manage credit card debt, you need to pay more. Ideally, you should pay off all charges in-full every billing cycle. This actually eliminates interest charges entirely. If you start and end each billing cycle with a zero balance, interest charges never apply. This also helps you avoid debt problems.
If you don’t pay in full then you should at least pay more. How much depends on your budget.
How much credit card debt is too much?
Most experts recommend that credit card payment should take up no more than ten percent of your take-home income. So, if you bring home $2,000 per month, you should only spend about $200 on credit card payments. If your minimum requirements are any higher than that, then you need to eliminate some debt; you also need to stop charging.
This means that many Americans today have too much credit card debt. Consider that average credit card debt is currently over $16,000. On a standard 2% minimum payment schedule, the requirement of the minimum payment is $320. If you’re bringing home less than $3,200 in income per month, you have too much debt.
Once you recognize that you have too much debt, you need to start exploring solutions.
Two things help you pay off credit cards faster:
- Lower the interest rate applied to the debt.
- Increase your monthly payments so you pay the principal off faster.