The Shocking Truth About Credit Card Interest: Why "Almost Paid Off" Can Cost You a Fortune
I recently listened to a podcast featuring the renowned MoneySavingExpert Martin Lewis which highlighted a crucial point about credit card usage that many people, myself included, are shockingly unaware of. This lack of knowledge could cost you a fortune.
So, let's uncover the truth about credit card interest and see if you could answer Martin's question.
The Question
Adrian buys a top-of-the-line coffee machine for £2,000 using his credit card. He has the money in savings to pay it off completely. However, just as he is about to make the full payment, he remembers a planned night out and decides to hold back £50, just in case. Instead of paying the full £2,000, he pays £1,950. His credit card has a typical high street APR of 24.9%. The question is: roughly how much interest will Adrian be charged for that month?
A) £0
B) £1
C) £40
Take a moment to consider the options. Which one feels most logical?
Let's break down the potential answers:
A) £0: Because Adrian paid significantly more than the stipulated minimum payment as given on the credit card statement, he won't be charged any interest.
B) £1: This suggests that interest will only be calculated on the outstanding £50: £50 at 24.9% APR (£12.45 per year), divided by 12 for one month, is approximately £1.
C) £40: This implies that because Adrian did not pay the balance IN FULL, he will be charged interest on the entire £2,000: £2,000 at 24.9% APR (£498 per year), divided by 12 for one month, is approximately £40.
If you answered C, congratulations! You have grasped a critical concept about how credit cards work.
The Crucial Lesson: Pay IN FULL
The reason we always say "Pay off your credit card balance IN FULL each month" is because anything less can trigger a significant interest charge. It is not enough to pay "nearly in full," "as much as you have handy," or even the "stipulated minimum payment." If you do not clear the entire outstanding balance, you will be charged interest on the whole amount, in Adrian's case, the full £2,000.
It may seem unfair, but this is precisely how credit card companies make their money!
They offer a period of interest-free credit (often around 56 days), but the price for failing to pay IN FULL at the end of that period is a hefty interest charge on the entire balance.
The Minimum Payment: A Safety Net, Not a Strategy
Every month, your credit card provider sends a statement detailing your spending, the total balance, the minimum payment amount, and the payment due date. Paying In Full and on time by this due date waives interest on all purchases - though not usually on cash withdrawals, which usually incur immediate interest and possibly a fee.
However, if you can't pay IN FULL, ALWAYS pay at least the minimum amount. Failing to do so constitutes a breach of your credit agreement and can result in late fees (around £10) and a negative mark on your credit file for up to six years. This can impact your ability to secure loans, mortgages, and even certain jobs in the future.
To avoid missing payments, set up a direct debit to automatically pay at least the minimum amount, or ideally, the full balance. If you anticipate difficulty making a payment, contact your provider immediately to discuss alternative repayment options. Proactive communication is key.
Credit Cards: A Powerful Tool, Used Responsibly
In a nutshell, a credit card allows you to make purchases now and pay for them later. The credit card company essentially fronts the money and sends you a monthly bill. If you pay this bill in full by the due date, you incur no interest charges.
However, if you opt to pay a smaller amount, the remaining balance is carried over to the next month, and interest is calculated on the whole balance until you repay it!
Used responsibly, credit cards can be valuable tools for building credit, managing cash flow, and earning rewards. However, it's crucial to understand the implications of not paying in full.
Remember Adrian's coffee machine: that seemingly small £50 oversight could have cost him £40 in unnecessary interest. Don't let a similar mistake cost you. Always prioritize paying your credit card balance IN FULL every month. This is the key to maximizing the benefits of credit cards while minimizing the risks.
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