What is the interest Rate?
Ok, I’ve gotten some heat for this idea, but I don’t care. I’m tired of hearing people bragging about their credit card’s low interest rate. Here’s why I don’t care whether it’s 5% or 80%.
What does “interest rate” mean on a credit card?
A credit card basically gives you a short loan for the month. If you pay it off completely during that monthly period, you don’t pay for the loan–it’s an interest-free loan.
But if you don’t pay off the entire balance–let’s say you spend $1, 000 on your credit card but can only pay off $500 that month–then you have a balance on your card. That’s what interest is charged on; typically, it’s somewhere around 20%. In this case, you’d be charged $8.33 that month ($500 balance * 20% interest) / (12 months).
Why I don’t care if my CC interest rate is 5% or 80%
It’s simple: I never carry a balance–and neither should you. If can’t pay it off at the end of the month, I don’t buy it.
I’m not going to belabor the point because, if you’re reading this, you clearly care about your money. But you would be shocked how many people I talk to that charge purchases without knowing how much they’ll actually pay for it. So let’s take a look…
Let’s say you have a $10, 000 balance on your credit card and you pay the minimum amount, which is around $250 every month. How much will it actually cost you? The answer is shocking. Get ready!
If you only paid the minimum on your $10, 000 balance, it would take you 452 months (over 8 years!) and cost you over $19, 000–in interest alone. In other words, you’d pay around $30, 000 for a $10, 000 balance.
This is why credit card companies are so incredibly profitable, especially with young people who don’t know any better.
The point is pretty obvious. Don’t carry a balance (if you do, pay it off as quickly as you can). Pay the maximum every time. If you can’t pay off a purchase by the end of the month, don’t buy it. “But Ramit, ” people say, “what about homes and college and cars? How can I pay that off in one month?” Yes, true, those very expensive purchases necessitate some kind of longer-term loan. But not with your credit card.
So when I hear people excited about their introductory interest rate (“It’s 0% for 6 months!!”), I’m not really impressed. As long as you pay your balance in full every month, your CC interest rate is meaningless.