Finances FYI Presented by JPMorgan Chase
You can earn reward points, build credit, and pay for large items using credit cards. These enticing perks have motivated more than 160 million Americans to open accounts. However, with careless credit card use, you risk building up debt, costly interest rates, and damaging your credit. This practical guide to swiping smartly shows you how to leverage credit card benefits safely.
Credit Card Fundamentals
Credit cards are notorious for high interest rates, leading to hundreds or even thousands more than your original purchase. Avoid building up debt and the costs of high interest rates through knowledge about how credit cards work and the discipline to use them wisely. Here are some basics to understand.
Interest Rates
Credit cards charge an annual percentage rate (APR) on card balances. This rate is calculated daily and added to your balance on your monthly statement. Say you have a balance of $6,000 (just below the average American credit card debt of $6,230) on your card, and your interest rate is 24% (the current average rate, according to Lending Tree). Here’s a simple calculation to estimate how much you will pay in interest each month, assuming the balance stays at $6,000 for the entire month.
24% (interest rate)/12 months= 2% per month or billing cycle.
$6,000 x .02 (2%) = $120 interest per month.
Can you afford an additional $120 a month? If you can, wouldn’t you rather spend it on something better than servicing your debt?
How to Avoid Interest
Fortunately, you can take advantage of credit card benefits while never paying interest rates if you follow one simple rule: Always pay off your balance. There is a grace period between purchasing something on your credit card and when interest starts accruing. You will receive your credit card statement shortly after your monthly billing cycle ends. You have until that statement’s due date to pay off the balance with no interest charged. Any remaining balance will start accruing interest.
The best way to always pay off your balance is to avoid making purchases you can’t afford. Build an emergency fund so you don’t rely on your credit card to pay for surprise expenses. Disciplined credit card users can charge bills and other purchases to a card they pay off monthly each month to earn points. But remember that it is almost never worth earning points if you pay interest or credit card fees on purchases.
Variable Rates
Sometimes, credit card companies offer 0% or lower interest rates to attract new customers. You can utilize these offers to pay for large purchases like replacing a broken appliance or on travel. However, if you don’t pay off the amount charged by the end of the incentive period, the interest rate will revert to the card’s regular, higher rate on the balance and any future purchases.
Be extra careful if the incentive is a deferred interest rate. You will also retroactively pay interest on the entire amount borrowed if it is not paid off by the incentive’s end. Some cards will also immediately end the promotion if you miss any payments.
Read the fine print of any credit card promotion so you don’t get stuck paying high interest rates. To ensure that you pay off the balance before the promotional period ends, calculate and make the needed monthly payment. Also, avoid making additional purchases that will make it more challenging to pay off the card on time.
Risks of Paying the Minimum Payment
Credit cards only require a minimum monthly payment. However, if you only pay this amount, it can take a long time to pay off your balance, and you will pay much more in accumulated interest. For our scenario, using a minimum payment calculator, paying just the minimum (average 2%) with a 24% interest rate, it would take more than 30 years to pay off the debt with total payments of almost $50,000.
Getting Out of Debt
You are not alone if you have built up credit card debt and are struggling to get out of it — 47% of Americans carried a credit card balance in 2023. Create a debt repayment plan that includes stopping all credit card purchases. You can use a credit card payoff calculator to make a plan. In our scenario, if you wanted to pay off the $6,000 balance at 24% interest in a year, you would need to pay $567 a month or $317 a month to pay it off in two years.
If your debt seems insurmountable, consider debt consolidation, where you apply for a loan to simplify payments and reduce overall costs. Approved credit counseling agencies can provide free or low-cost financial advice and education to help you create a debt management plan.
Finances FYI is presented by JPMorgan Chase. JPMorgan Chase is making a $30 billion commitment over the next five years to address some of the largest drivers of the racial wealth divide.
