The Problem of Debt and How to Get Rid of It.

Americans are being crushed under debt. We borrow money to buy the things we need. More often than not though, we borrow money to buy the things we want. According to NerdWallet the average American household has over $15,000 in credit card debt. That doesn’t even include a car loan or a mortgage. And credit card debt isn’t cheap. The average interest rate on a credit card is 18%. It can go even higher.

 

Now, what does that actually mean? First, let’s look at how credit cards work. We have to go back to high school math for this. Say you buy a new TV for 500 dollars. You put it on a credit card with 20% interest. Most store credit cards have even higher interest. And, for this example say you have a minimum payment of $25 per month. That would be about typical. How much will that TV actually cost you, and how long will you have to pay for it?

 

Just to make sure we’re clear on words. Interest is what the bank charges you to buy that TV for you and let you pay them back over time. The longer you tie up their money the more they charge you. Principal is the amount you actually borrowed. So in this example it’s the $500. In most loans you pay the interest and a little bit of the principal each time you make a payment.

 

If there was no interest the math would be easy. You would divide the 500 by 25 and you would get 20 months. Now with interest it will take a little longer. Generally interest is calculated every month. The bank will usually divide your interest rate by 12, since there are twelve months in the year and that’s how much interest you pay that month on whatever is still owed. So, if you owe $500 and your interest rate is 20% per year then the bank will divide 20%/12 and charge you 1.67% interest that month. 1.67% of 500 is $8.33. So before you can even pay towards the 500 you have to pay that interest of $8.33. Typically the bank doesn’t charge interest the month you make the charge, though. So you generally don’t start paying interest if you pay for all the charges you made that month.

 

Here’s a little table showing the month, payment that month, the amount owed before the payment is made, the amount owed after the payment is made, the interest added, and the amount that will be due next month.

 

Month Payment Total Owed Before the Payment Total Owed After the payment Interest Added For The Month Total Owed Next Month
1 $25.00 $500.00 $475.00 $7.92 $482.92
2 $25.00 $482.92 $457.92 $7.63 $465.55
3 $25.00 $465.55 $440.55 $7.34 $447.89
4 $25.00 $447.89 $422.89 $7.05 $429.94
5 $25.00 $429.94 $404.94 $6.75 $411.69
6 $25.00 $411.69 $386.69 $6.44 $393.13
7 $25.00 $393.13 $368.13 $6.14 $374.27
8 $25.00 $374.27 $349.27 $5.82 $355.09
9 $25.00 $355.09 $330.09 $5.50 $335.59
10 $25.00 $335.59 $310.59 $5.18 $315.77
11 $25.00 $315.77 $290.77 $4.85 $295.61
12 $25.00 $295.61 $270.61 $4.51 $275.12
13 $25.00 $275.12 $250.12 $4.17 $254.29
14 $25.00 $254.29 $229.29 $3.82 $233.11
15 $25.00 $233.11 $208.11 $3.47 $211.58
16 $25.00 $211.58 $186.58 $3.11 $189.69
17 $25.00 $189.69 $164.69 $2.74 $167.44
18 $25.00 $167.44 $142.44 $2.37 $144.81
19 $25.00 $144.81 $119.81 $2.00 $121.81
20 $25.00 $121.81 $96.81 $1.61 $98.42
21 $25.00 $98.42 $73.42 $1.22 $74.65
22 $25.00 $74.65 $49.65 $0.83 $50.47
23 $25.00 $50.47 $25.47 $0.42 $25.90
24 $25.00 $25.90 $0.90 $0.01 $0.91
25 $0.91 $0.91 $0.00 $0.00 $0.00

 

So by having the loan you end up paying more. You pay a total of $100 in interest. Your $500 TV ends up costing you a little over $600. That’s 20% more. The loan also ties up $25 of your money every month for 24 months. Even on months that you have something more important to pay for.

 

So, next time you want to buy something with a credit card think about how long it will take to pay it off, and the extra interest you will pay. Is it worth the extra money in interest?

 

So what can you do about it? Ideally plan ahead. If you know you are going to buy a $500 TV put $25 a month in a savings account every month. Then when the account reaches $500 you can buy the TV. This way you get it for cheaper. You can also skip a month when you’re tight on money, or if something else comes up. You can’t skip a month with the credit card.

 

But what do you do with the debt you already have? There are several strategies that you can use to get rid of it. The first step to each of them is don’t add anymore debt to the card. You can see more details in my post Strategies to Pay Off Debt. Below is a summary of what you can do.

 

Step 1. Don’t add any more debt to the card.

This is probably the most important step. If you stop adding to the debt you can pay it off. If you continue to add to it you may never pay the debt off. You will simply pay the bank more and more interest making the bank owners richer and yourself poorer.

Step 2. Always pay at least the minimum payment.

The minimum payment usually covers the interest and a little bit of the principal. It’s also the least amount that you can pay and keep the bank from getting upset. Paying this amount each month will keep your account current. Many credit cards will raise your interest rate if you don’t pay this. So missing it may cost you even more money.

Step 3. Pick one card and put your extra money to it.

This is how you start to get rid of the debt. Pick one card. This could be the card with the highest interest rate, or the card with the highest balance, or the card with the lowest balance, or even the card with the company you like the least. However you decide to do it, pick one card to pay off first. Put all your extra money to it and pay the minimum balance on your other cards. As soon as this card is paid off switch to the next card and do the same thing.

Step 4. Don’t add any more debt to the card.

Once a card is paid off don’t add more debt to it. That would only continue the debt cycle. Instead think of all the extra money you’ll have left over once you pay off the cards.

 

That’s the four, really only three steps to getting rid of the credit card debt. The hardest part is the discipline to stop using the cards and to pay extra each month. If it’s truly important to you to have a strong financial future then you can do it.

 

What strategies do you use to pay off your credit cards? Any strategies to keep yourself from using your cards?