Daily Compounding Interest and Credit Card Debt: How to Reverse the Cycle
Credit cards offer an appealing mix of convenience, added purchasing power and tantalizing reward programs. But there can be a dark side to credit card use, as many credit card users end up struggling with debt.
The first step to escaping credit card debt is understanding exactly how the card works. Once you’re armed with that knowledge, you can begin to figure out how to get out of credit card debt.
How do credit card interest rates work?
Credit cards allow their owners to essentially borrow money, spending money belonging to the credit card company. Each month, you’ll have the option of paying off the entire amount you spent, or else paying less.
If you pay less, the unpaid remainder is the balance, and credit card companies charge interest on the balance. These interest charges will mean that you’re paying back more than you spent.
What is a Minimum Payment on a Credit Card?
Typically, a credit card will have a minimum payment, which is the least amount of money you can pay each month against your balance without accruing late fees. But it’s important to understand that paying the minimum each month is not the same as paying off your balance.
If I Pay Minimum Credit Card Payment Do I get Charged Interest?
What happens if you only make the minimum payment on your credit card is you will still be charged interest on the remaining balance. This means that choosing to pay the minimum payment routinely will result in increased debt over time.
What Does Daily Compounding Interest Mean?
Most credit cards give you the interest rate in a yearly figure, the APY. However, credit card interest rates tend to compound daily, not monthly or annual.
This means that every day you’re carrying an outstanding balance, the balance will increase slightly due to the compounding of daily interest. In effect, you’ll be paying interest on your interest if you allow an unpaid balance to linger.
How To Pay Off Credit Card Debt
The first step to paying off credit card debt is acknowledging that you need to make a conscious effort to resolve your debt. For many people, it can be easy to be in denial while meeting minimum monthly payments and letting the balance compound and grow.
Once you’ve decided to confront the issue, there are a handful of strategies you can consider. Choosing which is right for you depends on your circumstances and means.
Lifestyle Changes
In some cases, the primary issue with credit card spending involves luxury or non-essential purchases. This might be online shopping, eating out at expensive restaurants regularly, or costly hobbies like attending sporting events or going out to clubs and bars.
If cutting out or reducing these types of purchases allows you to begin to pay down your balance, this might be your solution right there. This doesn’t need to be a permanent lifestyle change – You may be able to cut back on the non-essential purchases for a period of months or a year or two and then resume them when your debt situation is in better shape.
More Drastic Measures
In other cases, more significant steps might be necessary. Many people struggling with credit card debt use their cards to purchase groceries, pay for childcare, and other essential needs. And it’s not practical to cut too deeply in those areas.
One potential solution is debt consolidation loans. These loans allow you to pay off your balance and now pay a lower rate of interest on the debt consolidation loan. By lowering your interest rate, you may find that paying off your debt is now manageable.
Finally, personal bankruptcy is an option in the most challenging cases. Bankruptcy carries a variety of complications, restrictions and consequences and shouldn’t be done lightly. But it may be the only reasonable option available.
Still struggling with credit card debt? See how PDS can help you today.
