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Let's Run the Numbers - Informed Credit Card Payer

Don’t Say You Weren’t Warned! Who doesn’t love free stuff?  As an economist type, I love a free market more than most people. What I mean is “an economic system in which prices and wages are determined by unrestricted competition between businesses, without government regulation or fear of monopolies” according to Dictionary.com. A free market should, in theory, result in the best allocation of resources and the most efficient economic outcomes for all concerned. 

However, there are some conditions, in practice, that make a free market less efficient and less free.  The existence of externalities (pollution), imperfect competition (monopolies), and incomplete information are some examples. Whew! I knew I kept that old college econ textbook for a reason!

A lack of complete information available to market participants, mainly buyers, is a condition that rears its ugly head often (think of the used car rolled back odometer trick).  However, in one market, the amount and completeness of information has recently increased.  If you have a credit card and have looked at your statement recently, you’ve seen what I’m talking about. 

It’s the dreaded “Total Minimum Payment Warning.”  It states, “If you make no additional charges using this card and each month you pay only the total minimum payment, you will payoff the balance shown on this statement in X years.”  Let’s hope yours doesn’t say 37 years.  (This new information on statements is a result of the Credit Card Accountability, Responsibility, and Disclosure Act of 2009 and took effect in July 2010.)

Now that you are armed with this enlightening information, it’s up to you consumers to decide what to do.  You are free to plug your head back into the sand and pretend it isn’t true, or you can act as an informed, smart, rational market participant. How would that change things for you and the economy? 

Let’s run the numbers!

According to statistics from the Federal Reserve, in the U.S., the average balance owed for those carrying a credit card balance is $7,300 and the average annual percentage rate (APR) as of February 2010 was 14.67%.  I found a client with a credit card balance and rate in that ballpark and checked their warning.  Their balance of $7,167 carried a reasonable APR of 11.9% and their minimum payment is $141/month.  The statement reveals that, if they make the minimum payment only, it will take 25 years to payoff and the total cost (finance charges) will equal $13,934.  Holy guacamole! No wonder credit cards are a big business.  They sure make it easy to keep those finance charges coming by allowing you to make a lower minimum payment as the balance decreases. 

However, this informed, rational client instead can choose to stop using the card and make a payment of $141 each and every month until the account is paid off instead of decreasing the monthly payment as the balance declines.  This constant payment would result in the account being paid off in six years at a cost of only $2,854 or a savings of $11,080 over six years. Just imagine all the good that could come out of investing that $2000 per year instead into your retirement fund, a child’s education, the startup of a small business, home energy efficiency upgrades, your health, or your community. Get started you smart market participants, and efficiently allocate those resources!

By: Dave Werle, OnTrack WNC Certified Financial Counselor

United Way NFCC Council on Accreditation