Minimal Progress with Minimum Payments
One of my finance topics of choice from my Educating the Young About Money article was what it costs to make the minimum payment on credit cards.
Whenever I see an article about this topic, I dive right in because it’s absolutely incredulous. If you saw all of the numbers set out before you in a contract, would you really sign a piece of paper that says you’ll be making payments on your big purchase for 30+ years? We’re not talking a mortgage here. We’re talking your big-screen TV, maybe your dream vacation or that room filled with Ethan Allen furniture.
I thought it’d be interesting to take some of the big common purchases and show what the minimum will really cost you. Bankrate has a neato little calculator to help with this. I’m all about not reinventing the wheel unless I can do it better so Bankrate’s calculator, it is!
Here are the assumptions:
Interest rate: 15% (average right about now)
Minimum Balance computation: 1% of the balance + the monthly interest (most of mine use this formula). Keep in mind that this results in a declining minimum payment each month as your balance gradually decreases.
Taxes: withheld in my calculations since not all states have sales tax
Starting out small and in honor of Elana’s recent vacation:
7-Night Western Carribean Cruise on Royal Carribean* - $609 per person (interior room based on double occupancy)
Your Minimum Payment: $13.62 to start (innocent enough, huh?)
Cost of interest: $416.63
Total Cost of Purchase: $1,025.63
Time to Payoff if Paying the Minimum Payment: About 8 years!
* If you’re traveling with a spouse or family, this will make those numbers a lot larger. This also doesn’t include any of the spending, the airfare to your departing port if applicable, etc. See Elana’s articles on budgeting for her recent cruise and spending on those cruises.
Next up, another common weakness, gizmos and gadgets:
61″ Pioneer Flat-Panel HD-ready TV from Best Buy - $9,500
Your Minimum Payment: $212.56 a month to start.
Cost of interest: $11,671.19
Total Cost of Purchase: $21,171.19
Time to Payoff if Paying the Minimum Payment: About 32 years!
And finally, feeding my weakness for nice furniture:
Ethan Allen Newport Dining Room Set (dining room table, 4 side chairs, 2 arm chairs, sideboard and matching mirror) - $14,750
Your Minimum Payment: $330.04 a month to start.
Cost of interest: $18,316.62
Total Cost of Purchase: $33,066.62
Time to Payoff if Paying the Minimum Payment: About 35 years!
I’m going to take my last scenario and make a few minor alterations. The Minimum Payments listed above are based on a percentage of your balance and add in your interest for the month so every month they decrease as your balance decreases. If we just make that starting minimum payment every month as a fixed payment and disregard how the minimum payment decreases, watch what happens:
Ethan Allen Newport Dining Room Set (dining room table, 4 side chairs, 2 arm chairs, sideboard and matching mirror) - $14,750
Your Fixed Payment: $330.04 a month every month.
Cost of interest: $6,980.62
Total Cost of Purchase: $21,730.62
Time to Payoff if Paying the Minimum Payment: About 5 1/2 years!
Total Savings over paying the Minimum Payment: $11,336 and it’s paid off 29 1/2 years sooner!
Obviously the more you pay per month, the better off your calculations will come out in the end. The way I keep my spending under control is to not put anything on credit before I know how long it will take me to pay it off. If I can only afford to pay the minimum, then I really shouldn’t be buying it. For luxury purchases like the ones above, if I can’t get a 0% financing deal to use and pay off before interest is accrued, then I usually set a realistic goal like 3 months to have the entire purchase paid in full or I simply save for 3 months and pay for it upfront. I guess this is why I don’t own a high-end 61″ flat-panel TV or a fancy Ethan Allen dining room set, huh?
Does anyone out there have their own methods for how they decide what they can afford? Do you have limits for what you’re willing to finance?
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May 15th, 2006 at 11:33 pm
Hey! I’m a finance geek! I have one word to say about my vacation… okay three! PAID IN FULL!
And another about that dining room set, just one this time… IKEA (suits my need to constantly redecorate too.)
May 16th, 2006 at 2:18 am
Wow Elana, you must be good at budgeting your time too if you can constantly (minus the hyperbole even) redecorate.
I’ve never carried a balance. It just never occurred to me as a possibility. My credit card is a convenience for money in the bank. I had some friends who were going to when they just started out in the world and a financial geek aquaintance actually offered them an informal loan at half their card’s interest rate. (I, on the other hand, also think that loaning friends money is a different problem all together.)
I also haven’t made any huge purchases (like a car or house) yet though. Those would probably be done through credit union/bank financing.
I wonder if I should try to go crazy with a vacation fund and long term vacation fund and look into some sort of CD (yeah that long) or better source of interest.
…I wonder if fancy doll houses would satsify either of your two furniture fetishes
May 16th, 2006 at 6:01 am
Need and actually doing are two different things. Last year I took a week off work and redid the entire bathroom though. I like to swap out furniture so when I get the urge I save up some money and go to IKEA. Right now, I plan to put my current (once my grandmother’s but now getting beat up) coffee and end tables for the living room up on Craigs list and purchase a new coffee table. This is all, actually, part of me starting to (slowly) dress up the place to sell next year. In October of this year, the plan is to replace the kitchen countertop. Estimated amount using in stock countertop from Home Depot is $250. Labor is free (me, Carl and his Dad). The new coffee table I want? $100. I’m going to ask for $75 for the 2 end tables and coffee table and total going into the new one? $25.
May 16th, 2006 at 8:19 am
I’ve got an unusual situation in that my ING Direct savings account earns me more interest than some of the balance transfers on my credit cards will charge me. This works out wonderfully for me. I have my car on a credit card and I’m making more money having the extra funds in savings. It also means I had the title in my hand in less than 3 months after buying it.
Many people use credit and they run balances and pay interest all the time. For a big purchase, though, I really think the key to keeping everything under control is a) paying more than the minimum, b) knowing what your financing is costing you and c) having a target date when it will all be paid in full.
Elana, I had read a long time ago that when a couple first gets married, they start out IKEA and they eventually end up Ethan Allen. I like Ethan Allen but I have never purchased anything there. It’s all window shopping. Running numbers like I did above keeps me in check.