Interest Accumulation and Minimum Payments
In our previous article we talked about how the first time someone finances can be a crucial moment for the rest of their life. This is because when you pay for things with money that you actually have there is a fair amount of sacrifice taking place for each and every purchase. If you want that brand new furniture for the house and you know that it costs $2000 and you only have $500 you know that you will need to save the remainder. That could involve tightening the budget in some areas, picking up extra hours at work, selling old stuff, or some combination. The point is that you are having to put effort into making that purchase happen. When you actually have to put effort into something a few things happen and you will be more likely to:
- Appreciate the purchase that much more
- Understand the true cost of the items
- Spend more time deciding whether it is actually worth the price
- Do your homework and make sure that you aren’t overspending
When you are financing it’s less likely that you will do all of these things because let’s face it, it’s really freakin’ easy to just pull out the credit card and charge it.
See the difference?
There’s no effort involved there. Sure, if you were really planning on paying the purchase off immediately because you had the cash on hand it would be a different story, but that’s not what we’re talking about here. You’re short on the price tag, but you want it now!
It won’t be long before you’re adding lots of “little” purchases that you “need” onto the credit card because you’ve seen how small your minimum payments can be!
Remember from the last article? You got that furniture for $53.33 per month, sweet deal!
We already saw how the minimum payments can net you more in interest payments than the sticker price, but also consider that if you are adding more purchases to the credit card that your total monthly minimum payment will start to dramatically increase as well. It’s a much different ballgame with the minimum payment is $300-400 and you are starting to have to scrape to pull the payment together.
Maxing Out Your Income Each Month
If you didn’t have the money for your furniture purchase to begin with you probably don’t have a lot of disposable income in the first place, don’t budget, or have already gotten in over your head with the house you’re buying the furniture for. Let’s say you manage to max out that first credit card you used (the credit card probably also increased your credit limit for you too since they are so nice!) and you’re now sitting at $10,000 in debt. If we run that number through the calculator we have:
Minimum payment: $400 (4%)
Time to pay off: 171 months (14.25 years)
Interest paid: $6989
The key point here is that we’re now responsible for $400 each and every month to service this debt. If you are the head of a family with very little in savings it’s extremely likely that you will encounter an extremely expensive event that will force you to open up your wallet immediately in order to handle the situation. I can think of several just off the top of my head:
- Car breaks down
- Someone has a serious accident
- Children must have braces or other “out of pocket” medical expense
- Family member becomes ill and requires extra care
- Death in the family
- A move associated with a transfer or job change
These examples are just part of a very long list of possibilities. Each and every one of them could cost well over $1000 to handle and potentially much more. If you have to handle this expense and you start to miss your credit card payment you could be in a world of trouble. You will be hit with late fees, possible interest rate hikes, and embarrassing phone calls or letters.
You may be able to weather that storm and start the recovery, but what if something else happens? What if the minimum payment shoots up to $450 after late fees and a rate hike? The next surprising event will just knock you down even further.
This is where people get into trouble every time. Their minimum payments start to become a sizable portion of their overall income each month. It’s just common sense that you won’t be able to handle that type of situation forever. It’s extremely hard to save in this situation and you will actually have a tendency to finance MORE often even though you are already deep in the hole simply because you have no other source of payment.
You may be thinking this could never happen to me, but why? What if you had this first card maxed and then you had a death in the family with no insurance. Suddenly you are having to pay several thousand dollars to ensure that a loved one has a proper burial and that all of the arrangements are taken care of. It is not hard to imagine that you would be willing to open a second card to finance the $3000 because there was no other way to handle the burden.
What happens next month? You minimum payment shoots up to $520.
It’s only getting worse.
Debt Becomes “Normal” and People Stop Fighting
It’s a completely natural thing for people to get used to whatever situation they find themselves in.
If you live in an extremely hot area you will eventually get used to it and not be bothered as much. Heck, if you got slapped in the face everyday right when you woke up you’d probably get used to it too (this one might take a while). The point is that we are adaptable to a fault. If you are used to being in debt it will stop registering on your threat radar after a while. It will simply become part of your normal life. You can remember it being different a long time ago, but you don’t really see any way to get back to a clean slate so you just soldier on and deal with it.
Does this sound familiar?
Just like Rome wasn’t built in a day your debt did not appear overnight. Many decisions were made and circumstances arose to bring you to your current state.
If you give up at this point then it’s only going to get worse.
Who is saddled with so much debt that you have just stopped trying to fight it and you’re now just dealing with it day-to-day? Tell us about it in the comments and I’ll give you my support!