The power of $1
Date: Mon Jan 04 2021 ; Tags: Personal Finance »»»» Investing
Let us consider the effects of paying the minimum amount due on a bill, versus paying larger amounts. If you have already read my article Credit and credit cards then you are aware that the interest due on a loan amplifies the cost of the thing you bought. If you already have a debt, then what can you do to minimize the excess cost from the interest?
Let’s assume you have one credit card bill with a balance of $5,000 with a 15% interest rate. If you don’t charge any additional money to this account and pay the assumed $100 minimum amount due each month, it will take approximately 79 months (6.6 years!) to pay off this loan. At the end of this loan you will have paid $2895 in interest charges to use that original $5,000.
Paying just an extra $10 each month ($110 payment) will reduce the term of the loan to by an entire year and save you $459 in interest charges.
| Payment Amount | Cumulative Interest | Months Required |
|---|---|---|
| $100 | $2895 | 79 months |
| $101 | $2841 | 78 months |
| $102 | $2789 | 77 months |
| $103 | $2739 | 76 months |
| $104 | $2691 | 75 months |
| $105 | $2644 | 73 months |
| $106 | $2600 | 72 months |
| $107 | $2557 | 71 months |
| $108 | $2515 | 70 months |
| $109 | $2475 | 69 months |
| $110 | $2436 | 68 months |
| If you can pay an additional $25 each month ($125 payment), the loan will then be paid off in 2 years less time, and the interest charges would be reduced to $1,974 ($921 less charges in interest). | ||
| $125 | $1974 | 56 months |
We are all accustomed to making payments every month, approximately every 30 days. Since credit card companies don’t charge additional payment processing fees, why not send partial payments each month? As in the example above, if all you can afford is to pay $4 additional each month, split this payment in half and make two payments of $52.00.
How does a partial payment impact the process of paying down your debt?
Every credit card product is different which is why we often never truly can get a full understanding of them. Interest rates, Annual fees, Grace periods, etc., for credit card products vary greatly, which is why it’s so important to shop around for the lowest rate, the lowest annual fees, and the longest grace periods.
For example, some credit cards have a 22-day grace period while others have a 30-day grace period. This grace period is very important if you carry a balance month to month. The 15% interest, from the above example, is calculated on the previous month balance. If the bank is assessing a 15% fee every grace period, which, in many cases, is less than a full 30 days, interest charges can add up quickly.
By splitting minimum payments into partial payments (bi-monthly or every week), the outstanding balance on the interest charged to the previous cycle will be that much less.