Measuring the Horror of Credit Card Debt

We can learn a lot from simple questions.

Try this one. Suppose you have $1,000 in credit card debt. How much would you need to deposit in your bank to earn the interest to cover the cost of your credit card?

Would it be $1,000?

How about $5,000?

Or $20,000?

Or $50,000?

Nope, not one of these answers are correct. For most people it will be a much bigger number.

And the correct answer is…

According to the database at the St. Louis Federal Reserve Bank, the average bank credit card interest rate in March was 15.05 percent. The average rate on cards that carried a balance, however, was more: 16.61 percent.

So, if your card has a $1,000 balance, you’ll pay about $166.10 in the course of a year.

Next, let’s see what we can earn on money we keep on deposit.

Learning from NerdWallet

According to the NerdWallet website, the yield on the big bank savings accounts is, err, pathetic.  Bank of America comes in at 0.01 percent and tops out at 0.06 percent. Chase provides 0.01 percent, period. Citibank chips in 0.04 percent. And Wells Fargo joins the other Big Dogs with 0.01 percent.

Now we do the math. To earn that $166.10, you’d need to deposit $1,661,000 in the lowest paying big bank savings accounts. Yes, you read that right: nearly $1.7 million. Even if you get the top offer from Bank of America, you’ll need to deposit $276,833.

In fairness, I should point out that it is possible to do better. With a little effort at websites like Nerdwallet.com or Bankrate.com you can find a bank, usually an online bank, that pays more. Nerdbank’s most recent list of best savings account deals ranged from 1 percent to 1.41 percent.

So, you could cover $1,000 of credit card debt with as little as $11,780 deposited at the highest paying bank.

The ‘heads they win, tails you lose’ proposition from banks

The reality here is that the vast majority of our banks have been making “heads I win, tails you lose” offers for as a long as I can remember. In spite of that, many people still view their credit cards as a badge of honor. A lender trusts them. They must be good people.

The reality is different. Credit card lending is an abusive deal from the get-go. And if you’re late on a payment or provide some other excuse for a lender to raise the interest rate, you’ll see rates over 24 percent before you know it.

Does this mean credit cards are inherently bad? Absolutely not. It just means they are a convenient — but lousy — way to borrow money.

Credit cards smash cash

In spite of this, credit cards are the new cash. We use them more and more. They are what we use for transactions that were once the domain of “small change.” Credit cards are what most people use for all but the largest transactions. And we’re using even less cash since Covid-19, with the World Health Organization suggesting cashless transactions as a way to fight the virus.

According to recent data from the American Bankers Association, in late 2019 we collectively carried 374 million open credit card accounts divided into three categories. There were 197 million super-prime accounts, 103 million prime accounts and 74 million sub-prime accounts.

What’s the best thing to do?

Get on the winning side of the transaction. Get points or credits. Don’t pay interest. If you have a balance, pay it off ASAP. Make sure you pay the full balance each month. And pay before the due date to reduce the percentage of your credit limit that you’ve used. It will pay off in a higher credit rating.

Get rewarded for spending money if you can’t be rewarded for saving it

The rewards for doing this are substantial. For one thing, it feels good to know that your credit card purchases do a little something extra for you. I look at last year with nostalgia, remembering the Southwest Airlines trips and free companion flights with my wife. More recently, Amazon delivered a large garden fountain.

If the rewards for saving money are miserable – as I believe they will be for some time – then make sure you are at least rewarded for spending money.

Related columns:

Scott Burns, “The Next National Yard Sale,” 5/30/2020   https://scottburns.com/the-next-national-yard-sale/

Sources and References:

Federal Reserve report on consumer credit: https://www.federalreserve.gov/releases/g19/current/

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 Anna Shvets from Pexels

(c) Scott Burns, 2020