The Real Cost of Credit Cards

This post is a follow-on to Monday's post about time value of money. Credit cards can be great tools for managing cash flow or keeping track of expenses. I use mine for nearly 100-percent of my monthly expenses then pay it off in full at the end of each month.

Sometimes a credit card can be a temptation. Christmas and vacations are times many of us are lured into spending beyond our budget. We put it on the card then start the long, arduous process of paying it off.

One of the reasons we're so easily tempted is we're only looking at the price tag of the item we're buying. We don't look at the amount the item will actually cost us after we pay off our card.

As I mentioned on Monday, time value of money means a dollar today is worth more than a dollar tomorrow. Credit card companies are betting on us not knowing TVM. They hope we'll borrow a dollar from them today then pay it plus many other dollars of interest back in the future. They require extremely low monthly payments, so the amount of interest paid to them is maximized.

Mastercard has advertisements that say, "Disneyland tickets: $2,000. Meal at Disneyland: $120. Disneyland hotel: $600. A picture of your daughter with Goofy: priceless."

If you pay off your Mastercard at the end of the trip, the total price of that picture is $2,720. If you decide to pay the minimum monthly payment on that $2,720, the price of the picture is $5,685--An enormous hit to wealth building!

NOTE: My assumptions for this calculation are a $50 monthly minimum and 18% APR. Both of which are in line with many credit cards.

New laws require credit card companies to share information about how much interest you'll pay and how long you'll pay the minimum to get your card paid in full. Nonetheless, they want you to not know about time value of money. They are betting on you not knowing the picture will cost nearly $3,000 in interest.

If you're making a credit card payment, I'd encourage you to jump over to the financial calculator from the other day and run through your scenario. Enter the amount you currently owe (present value), your interest rate, your monthly payment (enter this as a negative number), and click on Periods. Multiply your monthly payment by the number of periods and you'll see the total amount you'll pay to get the card paid off.

Is there some way you could accelerate payoff to minimize the interest paid? Could you sell something? Do you have an optional expense that could be cut and applied to your credit card? If nothing else, can you start by not using the card any more?

NOTE: I just noticed today that you don't have to figure out what your monthly interest rate is. This calculator will do it for you. In the drop down box that says "Annual" choose monthly.