The Real Cost of Debt

Many people today think of debt as the amount you owe towards a credit card, mortgage or car loan. Few realize this isn’t the full cost of debt. When it comes down to it, debt goes deeper than a monthly payment and an amount owed. Every month you owe money, you’re debt increases and in the end, you’re paying much more than you signed up for.

The average credit card debt per American household is $15,799, according to a July 2011 CreditCards.com study. When you think about the amount of families with mortgage payments as well, it’s easy to see how people get in over their head with debt. It’s important to understand what debt is and what you’re really paying off.

What are you really paying off? Do you think it’s the amount you spend using a credit card? What about interest? It’s easy to think of credit card debt as simply paying off what you spend with your credit card, but let’s look at what is really going on. There are two things your monthly payment goes to on a credit card: principle and interest. Principle is the amount of money you spend with your card. With a car loan, it’s the amount of money you are loaned to buy your car. Then there’s interest. Interest is a percentage of the money borrowed that you pay the bank or credit card company on top of principle. Interest is always the first thing your payments go towards.

How much you’re actually paying is determined by your interest rate, which is in turn determined by your credit score. The average interest rate on a credit card is around 14%, which really adds up if you can’t pay off your credit card every month. Let’s look at a purchase scenario and how the interest adds up so you can understand the concept of how much you’re actually paying every month.

Let’s say you make a purchase for $1,999. It can be whatever you want, but in terms of this article, we’ll say it’s a flat screen TV. If you pay your minimum payment plus 1% of the purchase price, ($43.33/month) it will take you 14 years to pay off your new TV and it will cost you an extra $1,833 in interest alone. In just this one example, you can see how your purchase almost doubles in cost to you. When you have to pay interest on a credit card, the actual amount of money spent increases exponentially and you can really get into trouble.

If you want to understand the cost of debt you must take everything into consideration, and really think if that new TV is worth 14 years of payments. Credit card debt is a problem in America that is hard to get out of without the proper help and almost harder to stay out of without the proper spending habits. The more you understand the more prepared you’ll be to make smart choices with your money.

Learn more about how to get out of debt today!