Credit Card Debt – The cash flow killer
OK, so you’ve been caught in the system and your pile of money is not very big. As a matter of fact, you probably have a bunch of debt, most likely credit card debt. The kind of debt you have may be impacting your current life style.
What do I mean by this? Do you have school tuition debt? Do you have Mortgage debt? Or do you have consumer or credit card debt? If you have the latter of these, then you may be experiencing the cash flow squeeze. The debt payments you have to make, are eating into your ability to enjoy your life and impacting your lifestyle.
Credit card basics
Here I am going to dumb it down a little. I hope I don’t annoy you, but in my experience most people don’t understand the power of a credit card.
What is a credit card?
Credit cards are issued by an institution, not necessarily a financial institution like a bank, to consumers, as a form of short term debt. We all know what they look like. Behind the 1 ½ inch by 3 inch piece of plastic that we swipe and insert into little black boxes, is a huge financial lever that drives the economy. I like the definition that Forbes uses:
A credit card is a tool that allows you to offer someone else’s money, instead of your own, to pay for a product or a service today, and over time you repay the someone else. It is a loan, much like you would get when you buy a car, but this loan is pre-approved up to a certain amount, say $1000. The card allows you to use the loaned money to buy things until you reach the limit.
Sounds fabulous, right? The catch is that if you don’t pay back the “someone else” on time, they will charge you very high interest compared to other forms of debt like your car loan. These interest rates can be as high as 29% per year on any unpaid balance.
Who issues credit cards?
If you are living in the free world today, you probably know the answer to this one – Every Retailer and financial institution. The Retailer’s leverage their money to help you buy their stuff on credit making it easier to buy their stuff. They usually charge you the highest interest rates to do this. I have seen retailer credit cards as high as 29% (Sears, Home depot, etc). I have seen bank credit card interest as low as 9%. The average interest rate is 19%.
How do credit cards calculate interest?
This is where a credit card can be useful tool, or a nightmare.
First, if you pay off your credit card on time every month, you will never have to pay interest on the money. The credit card represents in this case a form of no interest money.
Here is where you can get into trouble with them. If you DON’T pay off the balance every month by the due date, then you will pay interest. Even though the institution has given you an annual interest rate, they don’t calculate it that way. You pay credit card interest on the “average daily balance” at the Daily approved rate. 
Here is an example:
Your credit card balance is $1000 on the due date of Mar 31. You pay off $500 of that balance and leave a balance of $500. You will now be charged interest at the daily interest rate on that balance. They calculate the daily rate by dividing the annual interest rate by either 360 or 365 days (19% / 365 = 0.052% per day).
You may think that you only pay interest on the $500. Not so fast. If you charge more purchases on your card, they will average your balance with the new purchases. The result – interest is calculated on $500 plus the extra purchases.
I hope you can see why you need to be careful with credit cards. If you don’t pay off the balance, it can be very expensive. Using “plastic” to pay for things can be risky if you don’t understand how they work or what you are doing. You can easily get in over your head very quickly and be unable to pay off the debt. The average household in North America is carrying $15,675 in credit card debt. That means they are paying an average of (19% x $15,675 = $2,978 ) $248 per month. What could you do if you had an extra $248 per month? I hope you can see why I call Credit cards, “the Cash Flow Killer”.
Until next time,
Wealthy ‘n Free Academy
