Minimum payment gives maximum pain
By Jennie L. Phipps, Special to Bankrate.com

Credit cards rule. Without those little pieces of plastic, holiday shopping would be much more difficult. But if we buy it, we have to pay for it. And if we buy it with a credit card, we have to pay for the privilege of using the card. Oh, the pain of it all.

Credit cards rule all right, so follow the rules for making the most of credit and come out way ahead.

Rule No. 1: Pay more than the minimum. If you read the fine print on the agreement you signed when you got the card, it ought to tell you how the debt will be computed. But sometimes it doesn't because those wily credit mongers would rather keep you in the dark so they can charge you more -- for longer.

If you don't see an explanation, you can probably safely assume that the debt will be collected 2.5 percent at a time. That means the credit card holder is asked to pay a minimum of 2.5 percent of what is owed in both principal and interest each month.

Before you shrug that off and say, "I can make the minimum," and move on to rule No. 2, let's do a little quick calculation.

If you charge $1,000 this holiday season at 18 percent interest, your first minimum payment will be 2.5 percent of $1,000, or $25. If you continue to pay the minimum 2.5 percent -- which slowly decreases over time -- it will take you 12 years and 9 months to be debt free. The interest you'll pay in that time will be a staggering $1,115.41. Check it out yourself with our minimum payment credit card calculator.

You can make this picture much prettier with higher payments. If you take that $1,000 debt at 18 percent interest and pay $40 a month, you can pay it off in 2 years, 8 months, and pay $262.46 in interest. That's better, but that big-screen TV that seemed like an irresistible bargain when you put on the card looks a lot more expensive with $262.79 tacked on.

Deep trouble

Howard Dvorkin, president of Consolidated Credit Counseling Services Inc. in Fort Lauderdale, Fla., has a smarter idea. His company counsels 350,000 people a year who have huge credit card bills and are in deep trouble. His advice to them -- and anybody else looking to use credit wisely -- is to triple the minimum payment.

What do you have to pay to be debt free in time for next year's shopping extravaganza? If, by Thanksgiving, you want to be able to hit the stores with your credit limit unfettered, come up with $100 a month. You'll be done in 11 payments and pay only $91.62 in interest -- a much saner plan. Run the numbers for yourself with Bankrate.com's credit card calculator.

Rule No. 2: Not all credit cards are created equal. For that reason, choose yours wisely. Credit card companies are out to make big bucks, but some are less greedy than others.

Current interest rates on credit cards range from about 8 percent to 25 percent. Some credit cards offer a much lower introductory rate, but in a few months the rate can soar into the stratosphere.

Avoid cards that carry hefty annual fees (try for one with no annual fee). Also, look to see how the company calculates interest. Avoid cards with "two-cycle average daily balance method" -- especially if you're trying to pay down debt. Under a two-cycle plan, your average daily balance is based on two months' spending instead of one. If you don't see this info in the small print, call and ask.

That done, check for an annual fee. If it's high enough, you might not see much advantage in a lower interest rate.

Card surfing

It's a good idea to "card surf," Dvorkin says. It works like this. Take a hard look at those dozens of credit card invitations that fill your mailbox. Accept an invitation to apply for a lower interest rate card, with an opportunity to transfer your balances from a current high-interest card. Before you sign up, check to see that the advertised interest rate is the same for balance transfers and that no extra fees are added for transfers. Again, you can always call the company and ask.

When you find the right card, complete the application, make the switch and start paying down the old debt at the new lower rate. Interest rate makes a difference. Let's say you've racked up a whopping $5,000 in credit card debt on a card that charges 19 percent.

If you're paying the minimum 2.5 percent every month, you'll be paying on this debt for 28 years and three months to repay your debt, and by the time you pay it off, you'll have coughed up $8,183.87 in interest. Ouch!

If you reduce that rate to 8 percent and still only pay the minimum, you'll cut the payment time to 15 years and four months and the interest to $1,739.56. It's still not great, but it's much better than before.

Tackle that debt

If you follow Dvorkin's advice and pay three times the minimum (or $375) on this 8 percent loan and keep paying $375 a month, you'll be done in a measly one year and six months. What's better is you'll only have to fork over $253.80 in interest.

If you can't transfer balances to a lower-rate card, tackle the debt on those 18 percent cards first. Pay as much as you can, and get that balance down fast because it's costing you a bundle. Let's say all you charge this holiday season is a conservative $500 -- less than half of what the average person charges at the end of the year. If you pay the 2.5 percent minimum starting at $12.50 a month, it will be 7 years, and $431.10 in interest before you send in your last payment.

Just thinking about it hurts.

-- Posted: Dec. 21, 1999