Do you like when companies make huge profits off of you?
I don’t particularly enjoy it.
For example, do you have any idea how much money credit card companies make in interest and fees off of us each year?
Hundreds of billions of dollars. Each. Year.
As we fail to pay our balances in full each month, we fall deeper into debt, and credit card companies make massive profits.
This is why credit card companies hope you only pay the minimum owed on your balance each month. When you carry a balance, they make a ton of money.
If that doesn’t sit well with you, don’t complain about unfair the game is. When you sign up for a credit card, you agree to play by certain rules.
Instead of wasting your time and energy griping about high interest rates, figure out a plan to pay off your debt. Stop giving the credit card companies any more of your money.
What can you do to stop making money for the credit card companies?
Start by understanding exactly how credit card companies make money off of you. This is what we’re going to focus on today.
If nothing else, always remember that banks are “for profit” businesses, and they’re very good at making profits.
Once you understand the rules of the game, you can create a budget to pay off debt.
Then, you can implement these 10 tips to pay off debt as quickly and painlessly as possible.
Let’s get to it.
Understand how credit card interest works so you don’t end up paying it.
If you’re going to use credit cards as part of your everyday life, you should understand the basics on how interest is charged.
Unfortunately, failing to understand how credit card interest works is an all too common mistake.
Here’s what you need to know.
Credit card interest is typically expressed as an annual percentage rate, or APR.
If you carry a balance on your card, the credit card company charges interest by multiplying your average daily balance by your daily interest rate. You will be charged this interest until your balance is paid off in full.
Credit card interest rates are typically variable, meaning they can change over time.
In the abstract, it can be difficult to fully appreciate how penalizing credit card interest is on our finances.
Let’s look at an example to better understand the consequences of carrying a balance.
Let’s say you just moved to a new apartment and purchased a $1,400 TV using a credit card.
You don’t have enough money saved up for the full purchase, so you decide to pay off $100 each month. Your credit card charges 23% interest.
At that interest rate, it will take you 17 months to pay for that TV. You will end up paying a total of $1,645, which includes $245 in interest.
The $245 in interest equals 15% of the original price of the TV. That means you paid 15% more than the TV actually cost.
If that doesn’t catch your attention, don’t forget this is just the interest on one purchase after moving to a new apartment.
What if you want to buy a new sofa to go with your TV? How about a coffee table and a rug? Floor lamp? End table?
You can see how a 15% penalty on each of these purchases can start to add up quickly.
Think about this added cost the next time you make a purchase expecting to just pay it off slowly over time.
Never miss a credit card payment unless you like making banks richer.
Write this rule down in stone: never miss a credit card payment.
If you don’t remember any of the other credit card tips, remember this one.
It may seem unfair, but even a single missed payment can severely impact your credit history and credit score.
Because the consequences of a missed payment are so severe, it’s a good idea to set up your account for automatic payments.
You have options when setting up automatic payments. Ideally, you can pay your full balance automatically each month.
If that won’t work for your situation, you can set up automatic payments for the minimum required amount to stay in compliance with your account terms.
By paying at least the minimum amount required on-time each month, you will not be penalized with a missed payment.
What is the minimum required payment?
Credit card companies typically only require customers to make a minimum payment towards their balance each month.
By the way, the banks want you to only make the minimum payment each month. When you do that, they make a lot of money off of you.
They get richer while you fall deeper into debt.
The minimum payment is generally 2% to 4% of your balance, or a predetermined minimum fee of around $35.
It may sound enticing to only pay the minimum. However, you will be charged interest on that remaining balance. That interest compounds and will be a major drag on your finances.
Let’s look at another example to see what happens when you only make the minimum required payment.
Let’s say you have a credit card balance of $2,000. Your minimum required payment will likely be between $40 and $80 to stay in compliance with your account terms.
In this example, assume the minimum required payment is $40. If you make the minimum payment of $40 out of your total balance of $2,000, that means your remaining balance is $1,960.
On the next billing cycle, you will be charged interest on that remaining balance of $1,960. At 23% interest, you will be charged $37.39, which gets added to your total balance.
So, on the next billing cycle, your total balance will be $1,997.39.
Let that sink in.
Even though you paid $40 last month, your balance only decreased by $2.61. Ouch!
Note: this example is for illustration purposes only and may not be precisely how your credit card company calculates interest.
Know the fees associated with your account.
Beyond interest and hoping you only make the minimum payment, credit card companies profit by charging fees, such as late fees and balance transfer fees.
Let’s focus on just one of the many fees: the annual fees tied to rewards credit cards.
These fees can cost hundreds of dollars annually and cancel out the value of any points you earn.
For example, if you have a credit card that charges an annual fee of $500, and you only earn $400 worth of points each year, that’s a losing proposition.
You’d likely be better off using a credit card that does not charge an annual fee, even if that means losing out on some points.
For that reason, it’s important to do your homework before applying for a new card.
Be strategic about what, and how many, credit cards you have.
There was a time in my life when I had ten different credit cards because I wanted to maximize the points I earned on every purchase.
I had airline branded cards, hotel branded cards, and general travel rewards cards. I had credit cards with Chase, American Express, and CitiBank.
My wallet was so thick it was embarrassing.
I did earn a lot of points. But, it was so stressful.
Keeping track of what card to use for every single purchase was complicated. Making sure I paid off each card every month was even harder. In the end, it wasn’t worth it.
I now keep things simple with just two credit cards and recommend you do the same.
I carry two credit cards in my wallet: Chase Sapphire Reserve and Chase Freedom Unlimited.
There’s no reason to overcomplicate it. I use the Sapphire Reserve for travel and dining and the Freedom Unlimited for everything else.
My wife and I still earn plenty of points and our finances are much simpler.
One other suggestion: if you’re in a relationship and share finances, I suggest you align your credit card strategies. Most major credit card companies allow you to combine points with a household member.
You can more quickly accumulate points by focusing on a single rewards program, instead of spreading out those points among various programs.
Same as me, my wife only carries the Sapphire Reserve and Freedom Unlimited.
Unless you want the banks to get richer, don’t spend money just to earn points.
When you have rewards credit cards, the temptation exists to spend money you otherwise wouldn’t because you want to earn more points.
It’s possible to become so obsessed with collecting points that you forget about the strong personal finance habits you’ve worked so hard to establish.
It can be easier to justify careless spending when we trick ourselves into thinking that spending will eventually lead to a vacation.
For example, if you have a credit card that offers bonus points at restaurants, you may be tempted to spend more money when you eat out.
Or, you may be tempted to pick up the tab for your friends even though that spending doesn’t align with your budget.
The temptation to earn points can overwhelm your plans to stay on budget. This logic applies to any type of spending, not just dining out and bar tabs.
Use your credit cards to spend within your Budget After Thinking, not as an excuse to justify blowing your budget.
Otherwise, all you’re doing is helping the banks get richer.
Help yourself get rich, not the banks.
If anyone is going to get rich off of my efforts, I want it to be me, not the banks.
By understanding how credit card companies make money, I can plan my actions in a way where I benefit instead of them.
It starts with not overspending. From there, I need to make sure I pay my balance in full each and every month. Finally, I need to make sure I’m not spending just to earn more points.
Following these steps is what led me to close out most of my credit cards and keep only the Chase Sapphire Reserve and Chase Freedom Unlimited.
Because I know how the game is played, I make sure I get all the benefits of having these two cards, not the bank.
Have you ever thought about how much money the credit card company makes off of you?
Do you agree with me that it’s not particularly enjoyable to help the banks make even more money?
Let me know what you think. I read and respond to every comment below.
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