The average credit card APR these days is ~17.69% (with many north of 20%).
Actually, with monthly compounding balances, the effective APR is almost 1 percentage point higher. So let’s say 18%.
What this means, in simple real-life terms, is that for every $1,000 of debt you keep on a credit card balance, you accrue an additional $180 of debt per year in the form of interest.
Taking it a step further, you would tack on $1,000 in interest payments (2X the original charged amount) every 6.25 years on every $1,000 accrued.
If you have credit card debt, that should be alarming enough for you to stop dead in your tracks, sell off all of their worldly possessions, and attack that debt from all angles like a rabid and starving Tasmanian devil on roids until the balance is paid in full.
Yet… for many, it’s not enough. The average credit card balance for Gen X is $5,343 and Gen Y is $2,682.
Is there Such a Thing as Justifiable Credit Card Debt?
There are indeed circumstances that would lead to an individual accruing credit card debt that they cannot pay off in full every month for a period of time that are justifiably excusable. Situations that come to mind include:
an individual that is out of work and emergency funds and needs a lifeline until they start earning a regular income again- a student or job trainee unable to take on more paid work due to a very demanding program or course load, or who has taken on a high profile unpaid internship
- a low wage earner with no savings, who is hit with unexpected necessary expenses (medical, transportation, unexpected household repair)
- you will come home to a horse head in your bed if you don’t pay off the mafia today
In these cases, the credit card debt would be justifiable, but only if all other options were exhausted first (selling off possessions, cutting expenses to only the bare essentials, moving to cheaper location, unable to tap a lower interest home equity line of credit).
For everyone else, you’ll have a hard time convincing me that credit card balances are justified (but try me in the comments, if you dare).
The Best Way to Look at Credit Card Debt, for the Masses
2X the original charged amount every 6.25 years might be eye opening and even motivational for many, but is it enough to develop a pure hatred for credit card debt that inspires immediate and continual action? Maybe not.
So lets try this way of looking at it…
Every dollar you spend or allocate to ANYTHING other than paying off your credit card debt comes with a personal 16% annual tax penalty. And each year after, you get taxed another 16%.
Ouch! Who likes taxes? And an additional 16%? That’s more than many people pay in income taxes! (the average effective tax rate for all but the top quintile (20%) of income earners in the U.S. is less than 16%). It’s like Uncle Sam just cloned himself, dressed up as a bank CEO, and taxed you all over again.
So think about this for a moment…
The discount new pair of shoes ordered online last night? 16% annual tax.
The morning latte? 16% annual tax.
The Chipotle burrito for lunch? 16% annual tax.
The takeout food on the way home? 16% annual tax.
The gas that fuels the long commute? 16% annual tax.
The latest, greatest phone and cell plan. 16% tax.
The concert tickets ordered. 16%.
The cable TV. 16%.
Even personal savings? 16% tax!
On the last one, I’m not just talking about things you buy with a credit card, but even things you buy with cash or the cash you are putting elsewhere. Why? Because that cash is being diverted from paying off your credit card balance to something else.
There is only one exception to the rule: 401K matching with rates that dramatically exceed your credit card APR’s – so long as you keep the funds invested.
As a species, humans are great at compartmentalizing things. And when it comes to personal finance, we like to compartmentalize even more: “I have this credit card balance here, savings there, and my expenses over there.”
Sometimes, compartmentalization can really work to your benefit (i.e. saving towards specific future goals). But when it comes to high interest debt, you’d be best off to throw compartmentalization out the window, because the reality is that all of your finances are connected. A dollar spent on anything other than paying off debt carries a penalty. How much of a penalty?
You guessed it.
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New to your blog :) Thanks for the post. That’s a great way to think about it: a “tax” equal to the amount of your APR for everything you buy and then carry over without paying off. Also a great point that the money going toward that “tax” can’t be invested somewhere else, negating potential returns and costing even more. That IS scary!
Now is the time to save. Dollars invested in the 20’s and 30’s compound much more than dollars saved later on. Get rid of CC debt and increase your effective savings rate NOW.
I pay off my credit card every month and there are two I have that I keep $0 balance on. I am constantly receiving (on a monthly basis) offers for 0% APR for 12-18mos (for a 2% transfer fee). I always keep the offers around in case an unexpected large expense comes up. That way I am not stuck with a 16%+ APR to deal with.
I have never paid a penny of interest to a credit card company. I went years without one and recently opened an Amazon card which has brought me a ton in cash back since I have had it. I pay it off every 3 days to ensure I pay no interest. I always tell people don’t get a credit card until you have mastered financial self control. Otherwise it will just cause problems.
Hi. I’m new to your site. Found it through a link from a Kiplinger article online. Very interesting info.
I had lived in the US for 8 years without a credit card because I felt I didn;t need it, I liked just using debit. But last year I got 2 cards which I pay in full every month to start getting some credit activity going. I have a great credit score in big part thanks to paying off my student loan in record time.
But yeah, I can never understand people with credit card debt and just the feeling that I owe something to a company makes me shiver.
Although this is all true, it’s important to note that credit cards are a great tool if used properly, due to their ability to built credit and earn points. I personally recommend and use the Amex Blue Cash Preferred and MasterCard uPromise card, both of which I learned about from this blog.
While completely abstaining from credit cards is certainly a better option than finding yourself in heavy credit card debt, using credit cards with good rewards programs on purchases you’d have made anyways and paying them off in full can be highly beneficial for your financial health. The trouble only comes when people say “Oh boy, points! Low minimum payments! Time to spend more money!” and then find themselves unwilling or unable to pay off the complete balance.
Totally agree. I have 7 cards myself, but I pay each in full each month. The benefits are plentiful, if you use credit cards wisely:
1. rewards points/cash back
2. purchase/fraud protection
3. rental car insurance coverage
4. ability to build your credit
5. ability to purchase or over the phone
This article was more geared to those in CC debt vs. trying to dissuade people from using them altogether.
Great look at credit cards! I have many people tell me this is the reason why they don’t have credit cards, but I always say I’ve made money off of them! Several friends have taken the Dave Ramsey “only pay cash” approach; I don’t feel comfortable carrying that much cash! Credit cards are tricky, but if you’re committed to financial independence … they’re great ;)
Whoa! What a way to look at it! We are very lucky that our credit card is only at 8.24% interest, so I have been guilty of using it as an emergency fund before, but 16% (a perfectly reasonable amount for a normal credit card) is just huge! Everyone hates taxes, so this makes perfect sense! Scary!