On Credit Cards

Breakdown

Credit card interest is typically very high. As of 2024, it's around 24% APR (annual percentage rate), which is an annoying way of saying about 2% every month. You can take your credit card’s APR and divide it by 12 to calculate the interest that will accrue on your balance each month. That ‘each month’ aspect of credit card interest makes it easy to fall into debt quickly if you’re not careful. If you bite off more than you can chew, you don’t have much time to fix the situation before the interest adds up. Let’s get into it.

Show me the numbers

Let’s run through an example of how quickly credit card debt can grow if you only make minimum payments. We'll assume a starting balance of $1,000, an APR of 24%, and a minimum payment of $25.

Month-by-Month Breakdown

1. Initial Balance: $1,000

2. Monthly Interest Rate: 24% (APR) / 12 (months) = 2%

Month 1:

• Interest for the Month: $1,000 * 2% = $20

• New Balance: $1,000 + $20 = $1,020

• Minimum Payment: $25

• Balance After Payment: $1,020 - $25 = $995

Month 2:

• Interest for the Month: $995 * 2% = $19.90

• New Balance: $995 + $19.90 = $1,014.90

• Minimum Payment: $25

• Balance After Payment: $1,014.90 - $25 = $989.90

Month 3:

• Interest for the Month: $989.90 * 2% = $19.80

• New Balance: $989.90 + $19.80 = $1,009.70

• Minimum Payment: $25

• Balance After Payment: $1,009.70 - $25 = $984.70

Summary:

• Month 1: Start with $1,000, end with $995.

• Month 2: Start with $995, end with $989.90.

• Month 3: Start with $989.90, end with $984.70.

Notice that despite making the minimum payment each month, the balance only reduces by a small amount (not $25), and a significant portion of each payment goes toward interest. After the 3rd month, you’ve paid $75(!) but the balance itself has only decreased by about $15 - the rest of that money went straight to your card company’s pocket. Poof, worst magic trick ever.

In fact, if you were to only pay minimum payments on that initial $1,000 balance it would take you almost 6 YEARS to pay it off, and in that time you would have paid over $1,000 in INTEREST (math). So to spend $1000, you spent $2000 - this is an extreme example in terms of length of time, but a very mild example when it comes to credit card balances. I’m pretty sure my first credit card at 18 had a $5,000 limit and I didn’t have $5,000 cash until I was well established in my career… at like 30 years old.

So… credit card bad?

Not necessarily, it’s kind of like a chainsaw… useful if you know what you’re doing but probably better to leave to someone else if you don’t.

Luckily, understanding the stuff I listed above (not chainsaws, the credit card part) here more than likely puts you ahead of more of your friends and family than you’d be comfortable with.

Credit cards can absolutely be beneficial, not just for building credit but also for the various perks and point systems they offer. My family and I primarily use the AMEX (shameless referral link) Gold Card since a huge chunk of our monthly spending goes towards groceries (…and dining out…), both of which earn bonus points on that particular card. I won’t go into details or breakdowns of which credit card is right for you, as there are a ton of resources out there (I personally like nerdwallet’s comparisons and breakdowns). Suffice it to say, there is likely a card that will give you the best bang for your buck based on your spending habits.

My family puts everything possible on that AMEX, but we also ensure we have the cash to cover every transaction and pay off the balance in full every month. This strategy is great for points but not super beneficial for building credit, as credit companies like to see you can ‘responsibly’ carry a balance forward to future months (including the interest you’d get by not paying it off in full).

If building credit is something you need to do, you could keep a small balance (an amount you could pay off in full at any point) on a card and make either minimum payments or some other amount not in full, allowing that card to incur some interest charges as you pay it off over a few months. Once you’re near zeroing out the card, put some more purchases on it and then repeat the process as needed. By keeping only an amount on the card that you could pay off at any point, you can feel comfortable carrying that balance and the minor interest charges that would be incurred over a few months as opposed to a few years.

Thanks for reading!

Jake

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Mandatory reminder

Hello friend, I’m thrilled to share my insights and findings with you. While I put a lot of effort into researching and presenting accurate information, it's always a good idea to double-check and verify anything you read online. Consider this newsletter a starting point, and don’t hesitate to do your own research to make informed decisions.

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