Let’s look at another example. Sally is carrying a $10,000 balance on her credit card. Sally’s monthly minimum payment is 2% of the balance, or $200, and the interest rate on the card is 18% annually.
If Sally makes just the minimum payment each month, it will take her 57.5 years to pay off her balance! Not only that, the $10,000 she put on the credit card will have cost her $33,930 by the time she gets it paid off.
But let’s say Sally always makes her minimum payment, plus an extra $100, or $300 a month. In this case, it will take Sally just under 7 years, instead of 57.5 years, to eliminate this credit card debt. In addition, her $10,000 that she spent on the credit card will only end up costing her $16,000. That’s a savings of over $17,000, which could have been used to eliminate other debts sooner.
Keep in mind as well that this example used a credit card that is charging 18%. With credit cards that charge higher rates (30%+) and things like payday loans, you can spend the rest of your life trying to get caught up. In either case, you’ve got to take drastic action to cut your debt now.
When we talk about minimum payments, we’re not just talking about credit cards, which is what “minimum payments” are usually associated with. Many other types of loans, such as “payment optional” mortgages, give consumers a lot of room to minimize their monthly payments, as long as they don’t go below a certain dollar amount.
The problem with this is that compound interest continues to march forward on your balance, especially when you pay just the minimum. In fact, your balance can actually grow if your minimum payment was less than the interest that was actually added to our account for that month.
Unfortunately, making minimum payments is human nature. To get out of debt, you’re going to have to go against the very fabric of who you are. By nature you instinctually avoid pain, and paying down a debt when there are other fun things that you can use your money for is painful! When given the choice between using all your disposable income to pay off a debt, and using some or most of it to enjoy life, you’re going to choose the latter. In fact, over the years, I’ve come to observe that when most people open their credit card statements, their total balance is not the first number they look at. People actually tend to check their minimum payment due before the balance!