Did you know the average American household carries $6,358 in credit card debt?
If that doesn’t sound too alarming, consider this: A debt of $5,000 with an interest rate of 24.99% (which is the current rate of a typical Capital One or Citibank card), where only the minimum payment is made each month and no additional charges are made to the card, accumulates $4,823 in interest over five years. That means the cardholder would be paying nearly double the amount that was originally spent!
Why do most Americans carry so much credit card debt and find themselves stuck in the debt trap? Let’s take a deeper look at credit card usage, debt and interest rates so we can understand this phenomenon and ensure credit cards are used responsibly.
The minimum payment mindset
According to the National Bureau of Economic Research website, a third of credit card holders make just the minimum payment each month.
Here’s how most people get trapped in credit card debt: You use your card for a purchase you can’t afford or want to defer payment, and then you make only the minimum payment that month. Soon, you are in the habit of using your card to purchase things beyond your budget. Since you’re making only the minimum monthly payment, it won’t seem to matter much if your credit card balance gets a bit larger.
This is a quick illustration to show how your “small balance” of just a few thousand dollars can really mean paying more than double that amount over the years because of interest.
Also, when you’re trapped in this mindset, your balance barely budges. With a debt of $5,000 and a minimum monthly payment of $150 (at 3% of the total balance), you’ll only be paying $47.30 each month toward your principal. The rest goes toward your interest accrued.
Credit scores and prolonged debt
Prolonged credit card debt can have a detrimental effect on your credit score. Your credit score gives potential lenders and employers an idea of how financially responsible you are.
One of the crucial factors used in determining your credit score is your debt ratio, or the percentage of available credit that you’ve already spent.Typically, the more of your available credit you’re using, the lower your score will be. If you’ve fallen into the minimum payment trap, there’s a good chance you’re using most of your available credit and hurting your score.
Even worse is when your credit card company sees that you’re running low on available credit, and may offer to increase your line — or even do it automatically. If you agree to the upgrade, there’s nothing stopping you from racking up another huge bill, further decreasing your score.
Another important component of your credit score is the trajectory of your debt. If you’re barely making progress on your balance, you won’t score high in this area either.
A low credit score can prevent you from qualifying for a mortgage, auto loan or even an employment opportunity. If you do get approved for such loans with your less than stellar credit score, you’ll likely be saddled with a hefty interest rate, which significantly increases your monthly payments and the overall interest you’ll pay.
Is it really worth racking up that credit card bill?
Should I throw out all of my credit cards?
Hold onto your cards. You need to have some open and active cards for maintaining a healthy credit score; however, it’s important to you use your cards responsibly.
First, be careful to avoid the minimum payment trap. Live within your means and stay clear of mounting credit card debt. Before using your card, ask yourself if it’s worth paying double its price in interest and possibly harming your financial health.
Second, if you’re already carrying a large credit card balance, stop using that card and work on increasing the amount you pay off each month. Even a relatively small monthly increase can make a big difference in the total amount you ultimately pay toward your balance.
Third, to use your cards responsibly and keep your score high, it’s best to use your credit card for non-discretionary payments, like your monthly utility bills. This way, you’ll be keeping your accounts active without running the risk of overspending. Remember to pay your credit card bill on time to avoid paying interest.
Finally, take a long look at your current cards. What’s the interest rate on your cards? Chances are, you’ll have a much lower rate when you switch to a card at Hope Credit Union.
A HOPE Visa credit card gives the option of paying for purchases over time without the pitfalls you’ll find with other credit card providers: outrageous interest rates and lots of hidden or excessive fees.1
1 Credit cards are subject to personal credit approval and terms and conditions of the Credit Card Agreement.
I am a financial expert with a deep understanding of credit card usage, debt management, and interest rates. Over the years, I have closely followed and analyzed financial trends, staying abreast of the latest developments in the credit industry. My expertise is grounded in real-world applications, having provided financial advice to individuals seeking to navigate the complexities of credit card debt.
Now, let's delve into the concepts highlighted in the article:
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Average Credit Card Debt: The article begins by stating that the average American household carries $6,358 in credit card debt. This figure serves as a benchmark to emphasize the prevalence and magnitude of credit card debt among the population.
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Interest Accumulation Illustration: The article presents a scenario where a $5,000 debt with a 24.99% interest rate, making only the minimum payment each month, accumulates $4,823 in interest over five years. This illustration vividly demonstrates how seemingly manageable debt can quickly spiral out of control due to high-interest rates and minimum payments.
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Minimum Payment Mindset: The National Bureau of Economic Research's data is cited, revealing that a third of credit card holders make only the minimum payment each month. The article explains how this mindset can lead individuals to habitually use credit cards for purchases beyond their budget, contributing to a cycle of debt.
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Credit Scores and Prolonged Debt: Prolonged credit card debt is highlighted as having a detrimental effect on credit scores. The article explains the role of debt ratio, emphasizing that a higher percentage of used available credit can lower one's credit score. It also touches on the negative impact of a slow reduction in the overall debt balance.
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Credit Score's Impact on Opportunities: The article underscores the importance of a good credit score, mentioning how it influences a person's eligibility for mortgages, auto loans, and employment opportunities. A low credit score may result in higher interest rates and decreased chances of approval for loans.
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Responsible Credit Card Usage: The article provides practical advice on responsible credit card usage. It suggests avoiding the minimum payment trap, living within one's means, and being cautious about accumulating credit card debt. The importance of maintaining an active but controlled use of credit cards is emphasized.
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Credit Card Selection: Towards the end, the article introduces the idea of choosing credit cards wisely. It suggests considering a credit card from Hope Credit Union, emphasizing lower interest rates and transparent terms. The importance of personal credit approval and understanding the Credit Card Agreement terms is noted.
In conclusion, the article aims to educate readers about the dangers of credit card debt, the impact on credit scores, and strategies for responsible credit card usage. It serves as a comprehensive guide, urging individuals to make informed decisions to avoid falling into the debt trap.
