Credit card debt is nasty business. Every month you throw your hard-earned money at your debt and yet your balance never seems to go down all. Your stagnant balance is the result of a banker’s best friend: insanely high interest rates, which he happily applies to your credit card.
High-risk means high interest
The average interest rate on a credit card is often cited at 15%, but that number is misleading. Banks can average out a lower interest rate by awarding low-risk customers (people who pay their balance in full every month) a low interest rate – often below 15%. Simultaneously, they spike the interest rate on higher-risk customers who borrow money using a credit card. Those rates are often higher than 15% and can even tip the scale towards 30%.
What does that mean in real terms?
You have $10,000 of credit card debt at a 20% interest rate.
You will have a minimum payment of approximately $276
Over the course of a year, you will make more than $3,000 of payments
$1,893 of that is interest
That equals an average $158 per month of interest to the bank
That high interest rate means that your hard-earned money is going into the pockets of bankers, rather than paying down your debt.
It’s no wonder that in our recent survey, 78.8% of Americans with debt believe that their interest rate is too high.
How to pay off your credit card debt
To get serious about paying down your debt, you need to keep two things in mind:
1. Can you pay more each month towards your debt?
2. Can you reduce the interest rate on your debt?
We know that brown-bagging lunch and cutting the daily latte habit gives you a nominal sum to throw at your debt, but the most effective way to pay down debt faster is reduce your interest rate.
(All while living below your means of course.)
In the example above, you would be spending nearly $2,000 in the next 12 months on interest. If you could cut that rate in half, you would take years off the time to pay off that debt.
Shopping for lower interest rates doesn’t show lack of character
Just imagine you are the CFO (Finance Director) of a business. You borrowed money to fund expansion plans. You are currently paying 20% on that debt. Banks are offering interest rates as low as 4%. But you don’t do the work to get the 4% interest loan, because you think it shows a lack of character. You borrowed the money, so you need to pay it off. It is highly likely that you would have a short career as a Finance Director. You would be fired. And your replacement would immediately re-finance the debt at 4%. The money saved could then be used to pay down the debt more quickly or re-invest in the business.
You should run your family financial affairs no differently. You should be looking to keep your interest expense as low as possible. You can then use the money you save to pay down your debt faster.
In most cases, the banks aren’t rewarding you for being a loyal customer. They aren’t operating with buy-nine-get-the-tenth-one-free coupons! Instead, the longer you have had your credit card, the more likely the rate is even higher than 30%.
Before the CARD Act was implemented in 2010, banks used to participate in a fiendish little trick called repricing. With little disclosure, banks could rapidly, dramatically and legally increase your interest rates. And they did it often
Just because you accrued debt on a card with Bank A doesn’t mean you should subject yourself to their abusive interest rates.
Time to start looking at a balance transfer
At MagnifyMoney, we love balance transfers. They are the single best way to reduce the interest expense on your credit card. If used properly — and you must follow the rules– you can slash your interest expense by 90% or more.
And when we did a survey, 89.1% of Americans who did a balance transfer in the past would do one again.