Continuing our series of articles on the 7 most common mistakes, this week we look at why making only minimum payments is a risky approach. These articles follow a trend of highlighting our responsibilities and accountabilities in dealing with our debt concerns or addressing how we approach our situations.
This is HUGE. If you’re barely scraping by then this does not apply to you, you can get immediate help below, but if you have the money to make bigger payments but aren’t making the effort, then take this very seriously.
It might be because you don’t clearly understand the impact of compound interest and how much money you’re wasting every year. Or you’ve got a mild case of head-in-sand syndrome so you’re making payments on time to keep your score afloat. But other than that, you don’t want to think about strategy or the mess you’re in.
For those of you who think I’m overstating the impact of compound interest, here’s an example so you understand what I mean.
Let’s assume you have R10 000 in credit card debt. And to make it easy to explain, let’s say it’s on one credit card and the APR (annualized percentage rate) is 15%. Minimum payment calculations vary a little by issuer, but we’ll assume this method to make it easy:
Interest plus 1% of balance.
In this example, your minimum payment for the first month is R225. If you only make the minimum required payment every month, it will take you 335 months—months— that’s 27.9 years!— to pay off your debt. During these 27.9 years, you will have paid R 11 979.29 in interest!
You’ll end up paying more in interest than your original debt total. Absolutely Nuts!
Let’s take a more aggressive approach to debt repayment. Now, you double the initial R225 minimum payment to R450. The results: Now you pay off your debt in 27 months, or two years and three months. You pay R1 788.72 in interest.
Quite a difference!
Not just in the amount of interest paid, but in the length of time you stay in debt. Do you want to pay off your debt in two years? Increase your payment to R500.
The result: You’re debt-free in 24 months! You pay a total of R1 579.47 in interest. Okay, so now you see the power of compound interest and how to disarm it with an increase in your monthly payments.
Yes, I know that many of you can’t find the money in your budget to use this strategy. But some of you can and should take this approach.
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