Think of
a credit card like this: When you charge something, the credit
card company is giving you a loan. When you don't pay the
whole balance you owe on a credit card, the bank or credit
card company charges you interest. The interest you pay is
written on your statement—in the fine print. The interest
is stated in terms of how much the card company charges per
year, so it's called an annual percentage rate (APR).
Your APR can be as high as 25 percent (or more) each year.
When you apply for a credit card, typically this information
is printed on the application form. If you have been "pre-approved,"
be sure you understand the APR. You can be unpleasantly surprised
if you don't understand what you've agreed to.
Calculate the Interest
To make sure you know how the interest will be calculated,
find the APR number on your statement.
Let's say your APR is 18 percent annually. Divide it by
12 (12 months in a year). This will show you how much interest
you are being charged monthly (18 percent / 12 = 1.5 percent
monthly).
Multiply your monthly interest rate by your credit card
balance (this is the total amount you've charged). Let's say
you've got a balance of $1,000. One-and-a-half percent, multiplied
by 1,000, equals $15.00 (.015 x $1000 = $15). This is the
amount of money you're paying every month for interest (also
called your finance charges). In a year that money will cost
you $180 ($15 x 12 = $180). This is how much it costs you
to borrow that $1,000. There may be additional service fees
as well.
What can you do about this?
Pay it off pronto. If your minimum credit card payment
is $10 a month, pay $20. Better yet, pay $100. The sooner
you pay it off, the sooner you'll save that $15 every month.
Try not to charge. If you can't resist whipping out that
card, put it in a safe deposit box in the bank. That way,
you'll avoid temptation. Or if you don't really need it,
cancel the account.
Transfer the balance to a lower interest credit card.
(But be careful of cards that offer "an introductory
rate" of 2.9 percent interest, for example. The APR
may go up substantially after a few months.) Here's a site
that can help you compare credit card costs: Bankrate.com.
Stealth Credit Card
When Bradford went to school, his dad gave him a credit
card with the instructions that Bradford use the card
for emergencies only. That September, Bradford stopped
by a table in the student union and filled out a credit
card application for a second card—one he could
control. (What his dad didn't know wouldn't hurt him,
right?) The credit card arrived, and so did the bills.
Within four months, Bradford was carrying a $1,000 balance.
If Bradford's card charges 18 percent interest, and
he only pays the minimum monthly amount of $20, it will
take him almost eight years (93 months!) to pay it off—and
that's if he never charges anything again! Plus, when
he adds up all the interest, his $1,000 credit balance
will end up costing him $1,860.
Now check out the following chart. It shows how, if
Bradford adds something extra to his minimum monthly
payment, he can slash the amount of time and money it
takes to pay off his card.
