There is only one tragedy greater than standing in your driveway at 6 a.m.
on a Saturday selling your Flowbee haircutting system for five bits to an
early-bird shopper. That is to be still paying it off on your Visa when this
transaction takes place. That's exactly what will happen if you pay by the
guidelines put forth by your purveyor of plastic, otherwise known as Paying
The Minimum Amount Due.
Fools don't pay by their rules.
Revolving credit cards (unlike American Express, which requires you to pay
the full balance each month) require only a minimum payment of just 1.5%
to 2.5% of your outstanding balance each month -- a calculation cleverly
designed to prevent you from paying off your balance before the apocalypse.
Seriously, pay by their rules, and it'll take you 44 years and 1 month to
pay down a balance of $4,500, even if you don't put another penny on the
card once you reach that limit.
And how much will $4,500 in cullottes, New Kids on the Block CDs, and products
guaranteeing they'd permanently remove unwanted hair or make desirable hair
grow end up costing? About $17,000.
As we urge in Step 2 of 13 Steps to Investing
Foolishly, the best financial decision you can make is to pay down your
debt -- before you even start investing. Ask your kid, your niece, or the
tike behind you in line at the grocery store, "Which sounds better, losing
18 percent of your cash a year, or making 12 percent on every buck you sock
away?" Go ahead. We'll wait.
In fact, while we're waiting, we'll do the math. Take an investor who comes
into a sudden $3,000 windfall. Although she has $3,000 in debt, she has heard
about the great returns she can get in the stock market. If an average year
on the stock market pushes holdings up 12%, can she beat the 18% growth rate
on her debt? Nope.
| Stocks vs Credit Cards |
| |
Stocks at 12%/Yr |
Credit Card 18%/Yr |
| At Launch |
$3000 |
$3000 |
| Year 1 |
$3360 |
$3540 |
| Year 5 |
$5287 |
$6863 |
| Year 10 |
$9317 |
$15701 |
A decade later, her debt has grown to over $15,000, her investments have
grown to over $9,000. Though she started with enough money to eliminate the
debt, she's now in the hole over $6,000. Until she sells those stocks. Then
she'll have to pay 30% of the profit back to the government in capital-gains
taxes. So she's actually out more than $9,000.
So you see, Fools, that money in your savings account earning 1.5%, that
can of change atop your dresser, even that portfolio that is bringing in
above-average returns will not beat the interest accruing on your credit
card. So roll up the dimes and pennies, dip into that savings account, even
hold off investing, and pay down that debt.
Use our Fool credit card calculators to figure out what it will take. Make a plan, and then stick to it.
Next up: A closer look at how your lender calculates your interest rate, and why, if you
are truly Foolish, you shouldn't care.
-- Dayana Yochim (TMF School)
Next: The Interest Rate »
See Also