Don’t look now but there is $1,000,000 in your wallet.
To find it all you need is your credit card and some time.
Here’s how:
- Start With Your Credit Card Debt. A typical household now carries over $4,000 in credit card debt. Each month, the credit card statement arrives. It lists charges and payments for the month, the interest charged, the new outstanding balance, and the minimum payment. The interest rate on most cards is still around 18 percent, which means that a typical card will cost about $60 a month in interest. No big deal.
- Examine The Monthly Payment. The minimum monthly payment on that card will be $80 or $100, depending on which formula the credit card company uses. Again, no big deal. If you subtract the interest charge from the minimum monthly payment, you get $20 to $40 dollars, a loan pay down amount so small it is likely to be lost against the background of new monthly charges. One consequence: unless you watch carefully, credit card debt tends to grow, not shrink. And you end up paying $60 a month in interest, month after month after month. You don’t just pay this interest for 3 or 5 years like a car loan. If you aren’t careful about paying down your balance, there is a good chance you’ll pay interest for the rest of your life.
- Pay Extra Each Month. If you make a constant payment of $80 a month and don’t make any new charges, you’ll pay this debt off in 94 months. Add $40 and the debt will be paid off in 47 months. If you take the long way, you’ll shell out $7,520 before the loan is paid off; If you take the short way you’ll pay $5,640 before the loan is paid off. Either way, paying off the balance is the only way you’ll eliminate the monthly interest change.
- Invest The Interest You Would Have Spent. If you invest that $60 a month and earn 10 percent it will accumulate to $4,646 in 5 years; $45,562 in 20 years, $135,629 in 30 years, and a whopping, $1,039,463 in 50 years. The table below shows how much the monthly interest payment different credit card balances would accumulate to over different time periods. Basically, the payoff for eliminating a credit card balance is somewhere between 20 and 95 times the balance— 20 times if a lifetime of credit card use is 25 years, 95 times if a lifetime of credit card use is 40 years.
The Long Term Payoff For Debt Reduction
| Years |
$2,000 balance or $30/m interest |
$4,000 balance or $60/m interest |
$5,000 balance or $75/m interest |
$6,000 balance or $90/m interest |
|
5 |
$2,323 |
$4,646 |
$5,808 |
$6,969 |
|
10 |
$6,145 |
$12,291 |
$15,363 |
$18,436 |
|
15 |
$12,434 |
$24,868 |
$31,085 |
$37,302 |
|
20 |
$22,781 |
$45,562 |
$56,953 |
$68,343 |
|
25 |
$39,805 |
$79,610 |
$99,512 |
$119,415 |
|
40 |
$189,722 |
$379,445 |
$474,306 |
$569,167 |
|
50 |
$519,732 |
$1,039,463 |
$1,299,329 |
$1,559,195 |
Source: Author calculations; assume 10% return on saved interest payments.
As you can see, the numbers get to be very impressive, even at low levels of credit card debt. Indeed, accumulating that amount of actual money is a lot more impressive than being able to buy things with a credit card.
- Use Your Card(s) For Convenience Only. You can still use your credit cards after you have no balance. You simply make certain that you never, ever, charge more than you can pay in any month. According to CardTrak of America, a bank credit card information service in Frederick, Maryland, there were about 212 million active bank credit card accounts at the end of 1996 and 71 percent of them carried a revolving balance. The other 29 percent used them for convenience only.
Query: Are there other areas of consumer debt with potential?
Answer: yes, but none so fruitful.
While the gurus of debt reduction sell the idea of paying off all debt and then investing the entire monthly amount, it is a fact that no other area of consumer finance has interest rates so high and principal payments so low as credit cards.
A 5 year auto loan, for instance, will cost $1,231 per $1,000 borrowed. Worse, some portion of that $1,000 borrowed will be lost in depreciation. Suppose, for instance, that you buy an average $20,000 car and finance it for 5 years. That means you will pay $24,620 over that period. If the car retains 50 percent of its original value, you will pay $4,620 in interest, lose $10,000 to depreciation, and accumulate $10,000 in car equity. Even if you pay cash for your cars, avoiding all interest charges, you’ll have depreciation. It will reduce the amount of cash available to invest, diluting the potential payoff.
Similarly, while the debt reduction gurus argue for quick home mortgage payoff, the length of the loan and after-tax cost of deductible interest makes parallel saving a competitive alternative to paying the mortgage off first and then saving.
But credit cards?
There’s a simple path of a cool million… and it’s in your wallet right now.
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
Photo by Andrea Piacquadio
(c) A.M. Universal, 1997