Credit cards are great. I’m a huge fan. More often than not they allow you to obtain basically 1% back on purchases, give or take. (That’s those points people are always going on about).
Unfortunately these are only great if you NEVER PAY INTEREST. In the case of credit cards this is simple. Pay your statement balance in full every month and you never need fear paying 15, 20 or even 25% interest.
How Bad is it to Pay Credit Card Interest?
Really, really bad.
If you maintain a $10,000 balance on your credit cards you’ll end up paying something like $200 per month just for the privilege.
If you can’t keep up with the interest, you’ll probably have to declare bankruptcy. The interest rates on credit cards are so high that your balance will double every 3 to 5 years.
So, let’s say that your $10,000 balance is getting charged interest at a rate of 25%. After 6 years the balance will be $40,000 and the annual interest will be $10,000. That’s right, after 6 years your annual interest is equal to your original balance!
So How DO You Avoid Paying Interest
It turns out to be simple, but as with most things, Saturday Night Live said it best.
This is all of Personal Finance
- Don’t Buy Stuff You Can’t Afford
- If You Don’t Have Money You Should Not Buy Anything
Problems In Life Have Solutions Which Fall on Two Axes
A solution can be simple or complex and the implementing the solution can be easy or hard. What does that even mean?
Well, it’s best to learn by example, if I have a bacterial infection I can take antibiotics (for the time being anyway). This is a complicated solution which is easy for me to implement. I am not clever enough to have come up with antibiotics. (Seriously, it would never have occurred to me that some mold could be used to fight bacteria.)
A complicated solution that is difficult to implement might be Chemotherapy. The treatment is complicated, and very hard to do.
A simple solution that is easy to implement is like making yourself a sandwich. You’re hungry. You just take some meat, bread and (hopefully!) veggies. Boom, sandwich.
A simple solution that is hard to implement is diet and exercise as a method of losing weight. It isn’t complicated, burn more calories than you consume, but it is hard.
People hate simple hard solutions, and they love complex easy solutions. Given the choice between a hypothetical pill that would make you fit and a regimen of diet and exercise who wouldn’t prefer the pill?
This is exactly why there are so many snake-oil salesmen in the personal finance game, there are a million get-rich-quick books. There are probably just as many lose-weight-easy books. There is no complex-easy solution to your finances, there is also no lack of people who will try to use complicated methods to bamboozle you into thinking they have an easy solution for your finances.
There is no easy solution.
There is only the simple solution.
You Must Spend Less Than You Earn
So what if you already are in a significant amount of credit card debt? Well, my rule of thumb is that you should treat anything you buy as costing 3x as much. Why?
That’s a reasonable rule of thumb for how much it’ll cost you after the interest.
What does this mean? Well, food is still worth buying. Need to eat, I’m willing to pay 3 times for food if that’s what it costs. Need to live somewhere; willing to pay 3 times for that too. I am not willing to pay 3 times as much to go to the movies. I am not willing to pay 3 times as much to go out to eat.
So if you have credit card debt, excluding your credit card payments and interest:
You Must Spend Less Than 1/3rd of What You Earn