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Financial Literacy

Financial Literacy

Payback Scenarios

The facts tell us that the average amount owed by all the Americans households that owe money on credit cards is $14,500. That’s almost five times what Clive Clueless, the intrepid mountain climber, found himself owing, but the logic is the same: if you make only the minimum payment on a credit card balance, it’ll take forever to pay off and cost significantly more than what you borrowed in the first place.

The average American has a little better deal on their card than Clive Clueless as a first-time credit card user:

• 14% APR
• $100 annual fee
• Minimum payment on this card is “interest plus 1%” or at least 2.167% of their balance a month (14% APR divided by 12 months = 1.167% plus 1%)

All that translates into a monthly payment of $300. And means credit card Joe is paying $170 a month just in interest.

Payment - $300
Amount that goes to pay interest - $170
Amount that goes toward paying off his balance - $130

And average credit card Joe has to earn $400 to come up with that payment because of income tax.

Joe's earnings - $400
Tax rate - 25%
Income taxes he pays - $100
Net after taxes - $300

If Joe makes the minimum payment, it’ll take over 30 years to repay his debt and cost him over $16 grand. Even paying $400 a month (and forgo buying that new car), it will take 4 years to pay it off.

Pay-off Plan Comparisons
Make large paymentsMake medium-sized paymentsMake minimum payments
Beginning credit card balance$14,500$14,500$14,500
Payment amount$800$400$314
Number of payments2148370
Balance after 24 months$0$8,149$11,392
Interest paid so far$1,887$3,249$3,626
Balance after 48 months$0$8,951
Interest paid so far$4,460$6,474
Balance after 10 years$4,341
Interest paid so far$11,852
Balance after 20 years$1,300
Interest paid so far$15,401
Balance after 30.8 years$0
Interest paid so far$16,417

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