True cost of credit card debt matters

Disclaimer: Upstart is not a financial advisor, the following content is for informational purposes only.

If you’re in debt, it’s likely more expensive than you may realize. The accumulation of debt that comes from your credit cards, car loans, or medical bills, comes with interest and fees, plus a mental price. Constantly worrying about the debt you have to pay off before you can save or struggling to pay your bills on time each month are not ideal ways to manage your money. 

In the U.S., 54 percent of Americans carry credit card debt from month to month. People aren’t always tapped into how much they’re paying in interest and fees, which adds to the true cost of their purchases.

Consumer debt is at $15.24 trillion towards the end of 2021, and spending is on the rise. The pandemic has added consumer debt—according to the 2021 Bankrate survey of 2,400 adults, 42 percent of consumers have accumulated more credit card debt since the lockdowns began in March 2020. 

With the rise in spending, it’s important to understand how much you’re really paying if you’re sitting on debt from month to month or if you tend to use your credit cards without thinking about interest and fees. 

Let’s examine how your debt is truly costing you and how you can improve the way you think about debt in general so you can better your financial situation. 

What is the true cost of making minimum credit card payments? 

If you tend to only pay your minimum balance on your cards each month, you’ll always be climbing an uphill road, especially if you freely use your cards while trying to pay it off.

An easy way to understand this is to think about a large purchase you would make on a credit card — for example, a $1,000 T.V. with an annual percentage rate (APR) of 18 percent. Your monthly minimum payment is $20, which is typically 2 percent of the total balance. 

So how much will this T.V. cost you over the life of these small payments you’re making? 

It would take about 94 months (over 7 years) and you’d pay around $862 in interest. This doesn’t even account for any fees, like an annual fee. Let’s say the credit card fee is $99 a year — that brings the actual cost to $1,962, nearly double the sticker price. Here is the breakdown:

    • Interest: 18 percent
    • Minimum payment: $20
    • Time to pay off the card: 94 months (over 7 years)
    • Interest amount: $862
    • Annual fee: $99
    • Total: $1,962
    • Amount you paid in interest and fees: $962

Principal vs. Interest and fees

It’s important to know how your payments are allocated because it may be one more reason you will change your habit of sitting on your debt for longer than necessary or making minimum payments on large purchases. 

The minimum payment of $20 would be allocated to interest and fees first, then the principal amount ($1,000). It would look like something like this:

  • Interest and fees: $15
  • Principal: $5

You can see you’re barely making a dent in the principal amount you owe, and most of your $20 is going to paying down interest and fees. 

Bottom line: The total cost of the T.V., plus the structure of how interest is applied means it makes more sense for you to pay down this balance as quickly as possible. 

Before you buy

The next time you see a deal that is too good to pass up and are tempted to use your credit card, think about how expensive that $1,000 T.V. was and how long it would take to pay it off if you made minimum payments. 

Hot tip: Use an online credit card calculator to help you figure out the true cost of the debt and a breakdown of payment allocation. 

There’s nothing wrong with snagging a great deal, but having a plan for how you want to pay it off or saving up cash could help you avoid falling into a long cycle of debt.

Debt consolidation methods

If you’re sitting on high-interest credit cards that you know will take you a while to pay down, there are a few options to help you consolidate them into one, low-interest payment. Having one payment to worry about, rather than multiple payments is easier to keep track of and pay on time each month.

You may consider the following options, but keep in mind debt consolidation won’t be the answer. It’s a tool to help you lower the amount you’re paying in interest. 

  • Personal loan: This is a way to pay down your credit card bills at once. If your credit score is excellent, you may qualify for a lower interest rate than what you’re paying on your credit cards. Upstart partners with banks to offer personal loans — see what rate you qualify for.

  • Balance transfer: You could also move your credit card balances over to another credit card. Many credit cards offer 12 months or so without interest when you transfer your balances. Remember, if you can’t pay off the balance within the given time frame, your interest rate will go back up. There’s also a balance transfer fee of around 3 percent to consider. 

Understanding the true cost of debt to set you up for success

Credit cards aren’t the enemy — they can be a useful way to pay for items we need or help out in the event of an unforeseen event. 

When you understand how credit card interest, fees, and how payments are allocated each month, it widens your perspective on how much you’re actually paying for things. It may prompt you to take a step back and assess your budget, your financial goals, and how you can spend less and save more.  

If you plan on using credit cards, consider avoiding the mistake of only paying the minimum balance. Make it a goal to pay it off in full so you can sidestep having to pay interest all together. 

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