Barbara Hause MBA

Synopsis : "The Good, the Bad, and the Ugly"

Making minimum payments for a period of time can also make sense for couples and individuals who seriously want to get out of debt.  It is so easy to get caught in a debt cycle when paying off credit card balances becomes a priority and little attention is given to future needs and unexpected expenses.

Here’s an example.  Hank and Sylvia Smith owed $22,430 in credit card debt.  They earned enough income to cover their monthly expenses and pay more than the $580 a month minimum payment.  During this time they also received a tax refund and decided to use that money to pay off even a bigger chunk of their credit card debt. It felt like they were making progress until the water heater broke and an insurance premium came due they had forgotten about.  Since they were spending all their extra income on debt and hadn’t been saving any money at the same time, they had to use their credit cards to replace the water heater and cover the premium due on their insurance bill.     

If Hank and Sylvia had paid the minimum payments each month instead of paying larger amounts and put their tax refund into a savings account, they could have paid for the water heater and the insurance premium without using credit cards.    Even though they will be making minimum payments for a while, saving at the same time is a step to break the debt cycle and stop the use of credit cards. 

At some point Hank and Sylvia will need to pay more aggressively to get out of debt.  However, making minimum payments gives them time to figure out a spending plan to live within their means.   This is also a time for them to look at what caused the debt and decide what they are willing to do to change behaviors.   With a spending plan the Smiths will be able to determine what they need to save each month as well as what they can afford to pay above the minimum payments on their credit cards.

After working out a spending plan, the Smiths’ determined they could save money and pay $700 ($120 more than the minimum payment) a month towards credit card debt.  With their new payment plan the Debt Reduction Planner calculated they would be debt free in 3 years and 4 months (vs. 25 yrs) and save over $14,000 in interest.
 

The Bad
Most of us know paying only the minimum payment each month on credit card balances will cost a bundle and take forever to pay off.  According the debt reduction planner calculator found on the web a credit card balance of $6900 at 11.15% interest with a minimum payment of $190 will take 13 years to pay off and cost $3169 in interest.  This means paying a total of $10,069 for purchases that originally cost $6900 which may have been for a vacation long forgotten about or items that are outdated or worn out.  

The Ugly
Paying minimum payments on multiple cards cost even more and will take longer to pay off.  According to the debt reduction planner calculator 3 credit cards with balances that total $22,430 with the average interest rate of 14.6% and total minimum monthly payment of $580 will take 25 years to pay off and cost $19,876  in interest.  This means paying for a quarter of a century almost double the cost of the original purchases.
 
At the website, www.cnnmoney.com, you can find a calculator called the "debt reduction planner".  On the home page click personal finance, click calculators, click debt reduction planner.   You will be able to type in the outstanding balances, percent interest, and minimum payments for one or more credit cards. The debt reduction planner will calculate the cost and time it takes to pay off outstanding balances by making minimum payments, by selecting a fixed payment of your choice or by setting a goal to pay off debt by a certain date.

Now pay off those credit cards.  "Go ahead, make my day."