Ramit Sethi: ‘The Common Pitfalls People Encounter with Credit Cards’
Using a credit card can be tempting because of the convenience, potential rewards, and the ability to pay for large purchases over time. However, if you’re not careful and strategic about how you use it, a credit card can quickly become a financial burden that drains your income.
Ramit Sethi, a financial expert and author of “How To Get Rich,” highlighted in a LinkedIn post how making only the minimum payments on your credit card can lead to trouble.
### Why Minimum Payments Are Problematic
Minimum payments are typically just 1% to 4% of your card balance, which might seem manageable when you’re on a tight budget. However, this approach can take years to pay off your balance, during which time interest continues to accumulate. The national average interest rate is around 21%, which can add up quickly.
You might find yourself dedicating a significant portion of your income to pay off purchases you made years ago. Even if you have a decent income, these payments can make you feel financially strained. Sethi described this interest as “invisible quicksand” that pulls you down.
Additionally, the money you spend on credit card payments limits your ability to invest or save. Sethi pointed out that instead of paying off $10,000 worth of furniture over 30+ years, if you had invested that amount and earned an 8% return, it could have grown to about $27,000.
### Real-World Examples
To illustrate how credit card interest can waste your money, Sethi provided some examples with a card that has a 27% annual percentage rate and a 2% minimum payment requirement. In these scenarios, it could take 30 years or more to pay off the card, and the interest could end up costing 13 times the original purchase amount.
For example, if you bought a $1,000 phone and made only the minimum payments, you could end up paying over $13,000 in interest. A $10,000 furniture purchase could result in a staggering $132,000 in interest.
You can use a minimum payment calculator, like the one from GreenPath Financial Wellness, to see how much a potential purchase might cost you in interest. You’ll need details like the interest rate, purchase amount, and minimum payment percentage.
### How to Avoid Credit Card Trouble
Sethi advises that the key to using credit cards effectively is to pay off your balance in full every month. While this requires good money management skills, it can save you thousands in interest and keep your future income available for other opportunities.
If you’re already in debt, you can still reduce the impact by paying off your balances as quickly as possible. Focus on the cards with the highest interest rates first. It might also be worth considering balance transfer promotions with 0% interest for a limited time.