As students get older, they will begin to get bombarded by credit card offers. How smart is it to get a credit card? How much is too much? How long does it take to pay off a credit card? These are all questions that deserve to be explored by every student before they graduate high school and so a few of them will be explored in this investigation.
Here is the scenerio. You have a credit card on which you spend $1, 000 for Christmas. Your New Years Resolution is to pay off your credit card and you will not spend anymore money on it until it is paid off. You will pay $100 on the first of every month, begining with January 1, until it is paid off. Your card has a 20% APR. How long will it take for you to pay off your card? How much will you have given the credit card company in interest during that time? To answer these problems we are going to create a spreadsheet in Excel. Since we are making payments every month we will assume the credit card is being compounded monthly. That means each month we will find the interest for the balance at that time and add it to how much we owe the company. We have a 20% ANNUAL Percent Rate. Therefore we have a 20/12% MONTHLY Percent Rate. This is very important distinction or else we will really scare ourselves when we calculate monthly interest. The way we will do this is take what the balance was after we made our payment the month before (we call that previous balance), find the interest and add that to our balance to get adjusted balance (previous balance*(1+.2/12)=adjusted balance), then subtract off our payment to get new balance (adjusted balance-payment=new balance). Let's see how that looks.
Not too bad. The credit card is paid off by the end of the year. When we add up the monthly interest column we see that $103.04 was given given to the credit card company for interest. But, the key question is will you make $100 payments every month and spend nothing else on the credit card? The answer is probably no. Many credit card holders pay only the minimum payment every month. Let's redo this problem and pay only the minimum each month. Our credit card says that the minimum payment is $20 or 5% of the total balance, which ever is more. In the beginning when we have $1,000 on our card it should clear that 5% is $50 which is more than $20. Therefore when we are calculating our payment we will find out what .05*Adjusted Balance is. That will be our payment whenever it is greater than $20. Now let's see how long it takes to pay off.
Wow! That is a big difference. Now it takes over 4 years to pay off the credit card! All from one generous Christmas. No more spending on that credit card for the entire four years. Incredible. Even worse is that we gave the credit card company $383.16 in interest. That means that of the $1383.16 we sent to the credit card company over the past four years 28% of that was just for interest. Talk about throwing away your money.
One last case. Let's say you just can help yourself. Every second Friday you just have to buy a $10 pizza on your credit card. Using that you are still making the minimum payment, how long will it now take you to pay off your credit card?
Tsk, tsk. It is now going to take almost 10 years to pay off that credit card. That means if you buy a computer your freshman year of college and then behave in the way that has been described it will take you until you are almost 30 years old to pay off your credit card. And that is with only buying one $10 pizza a month. In this scenerio $790.60 was given to the credit card company for interest alone!
Hopefully, you have been convinced to act responsibly with a credit card. First, make payments higher than the minimum, as high as you can afford to. Second, don't keep adding purchases to a credit card that you want to pay off. Third, spend on the credit card as little as possible. Skymiles, cash back and other incentives may sound tempting but with the amount you are giving the company in interest you have paid for you "freebies" and then some.