The Credit Card Trap


The Credit Card Trap

I’ve already discussed credit card myths in previous blogs, and I could go on and on with many more. But the main reason you should be very careful with credit cards (or card as I suggest you have only one) is simply because you’re going to spend more money when you use it. Yeah, I know, you’ll pay it off in full every month and therefore it won’t cost you a penny. But even if you are one of the small percentage of people who do pay it in full every single month, you still have to watch out. Studies show that a shopper spends an average of 38% more when using a credit card instead of paying with cash. In the grocery store they spend 50% more.

And notice I said small percentage, because that’s the case. Statistics show that about 1/3 of all Americans pay their credit cards in full every month. But that’s actually misleading. What it means is that every month about 1/3 pay in full and 2/3 do not. It does not mean that the same 1/3 are routinely paying in full every month. A person who pays in full one month may get behind the next month. Or a person who gets behind for a few months may eventually catch up. But only about 10% are always paying in full every single month. The other 90% play the card shuffle of getting behind, catching up, and getting behind again. Sure, you may insist you’ll be in the 10% that is always caught up. But of the 90% who are at least sometimes behind, how many of them do you think planned on doing that? I’m guessing not a single one.

Paying interest on stuff you buy just for the convenience of using a card is insane. If you were in a store and saw a sweater and the sign next to it read, “$100 if you buy today, $125 if you buy tomorrow” would you not think that was nuts? Of course you would. You might even find the store manager and ask him if he’d lost his mind. But when you buy an item on a card that has a 25% interest rate, and you don’t pay it in full, then that’s exactly what you’re doing. You’re paying an extra 25% for the convenience of paying later.

Perhaps paying 25 extra bucks here and there doesn’t concern you. Well, here is a bigger way to look at it. Let’s say your card has a 25% interest rate and you’re carrying a $10,000 balance (about the average balance in America, believe it or not). That’s $2,500 a year you’re paying in interest. Over ten years that’s $25,000. Now suppose instead you paid the card off and invested that $2,500 a year into a decent mutual fund that averages 11% interest a year (the average annual return on the stock market for almost 90 years now). After 10 years that $2,500 a year would be worth over $45,000. Would you rather HAVE $45,000 or OWE $25,000? That’s a $70,000 swing in your favor.

Now suppose you did that for 20 years instead of ten. If you continued paying credit card interest you’d be paying a total of $50,000. But that money invested instead would give you more than $181,000. A $231,000 advantage to you! And notice how the amount you invested ($50,000 instead of $25,000) and the time it took (20 years instead of ten) were only doubled, the amount you ended up with more than quadrupled. That is the magic of compound interest which I’ll talk about in a future blog. If that doesn’t want to make you stop using your credit card, then I don’t know what will. As I always say – Interest should be MADE, not PAID!