Credit cards are great. I’m a huge fan. More often than not they allow you to obtain basically 1% back on purchases, give or take. (That’s those points people are always going on about). Some give back at most 10%.
Unfortunately, these are only great if you NEVER PAY INTEREST. In the case of credit cards, this is simple. Pay your statement balance in full every month and you never need fear paying 15, 20 or even 25% interest.
How Bad is it to Pay Credit Card Interest?
Really, really bad.
If you maintain a $10,000 balance on your credit cards you’ll end up paying something like $200 per month just for the privilege.
If you can’t keep up with the interest, you’ll probably have to declare bankruptcy. The interest rates on credit cards are so high that your balance will double every 3 to 5 years.
So, let’s say that your $10,000 balance is getting charged interest at a rate of 25%. After 6 years the balance will be $40,000 and the annual interest will be $10,000. That’s right, after 6 years your annual interest is equal to your original balance!
So How DO You Avoid Paying Interest
It turns out to be simple, but as with most things, Saturday Night Live said it best.
This is all of Personal Finance
- Don’t Buy Stuff You Can’t Afford
- If You Don’t Have Money You Should Not Buy Anything
Problems In Life Have Solutions Which Fall on Two Axes
A solution can be simple or complex and the implementing the solution can be easy or hard. What does that even mean?
Well, it’s best to learn by example, if I have a bacterial infection I can take antibiotics (for the time being anyway). This is a complicated solution which is easy for me to implement. I am not clever enough to have come up with antibiotics. (Seriously, it would never have occurred to me that some mold could be used to fight bacteria.)
A complicated solution that is difficult to implement might be Chemotherapy. The treatment is complicated and very hard to do.
A simple solution that is easy to implement is like making yourself a sandwich. You’re hungry. You just take some meat, bread and (hopefully!) veggies. Boom, sandwich.
A simple solution that is hard to implement is diet and exercise as a method of losing weight. It isn’t complicated, burn more calories than you consume, but it is hard.
People hate simple hard solutions, and they love complex easy solutions. Given the choice between a hypothetical pill that would make you fit and a regimen of diet and exercise who wouldn’t prefer the pill?
Reality Check
This is exactly why there are so many snake-oil salesmen in the personal finance game, there are a million get-rich-quick books. In fact, there are probably just as many lose-weight-easy books. However, there is no complex-easy solution to your finances, there is also no lack of people who will try to use complicated methods to bamboozle you into thinking they have an easy solution for your finances.
There is no easy solution.
There is only the simple solution.
You Must Spend Less Than You Earn
So what if you already are in a significant amount of credit card debt? Well, my rule of thumb is that you should treat anything you buy as costing 3x as much. Why?
That’s a reasonable rule of thumb for how much it’ll cost you after the interest.
What does this mean? Well, food is still worth buying. Need to eat, I’m willing to pay 3 times for food if that’s what it costs. Need to live somewhere; willing to pay 3 times for that too. I am not willing to pay 3 times as much to go to the movies. I am not willing to pay 3 times as much to go out to eat.
So if you have credit card debt, excluding your credit card payments and interest:
You Must Spend Less Than 1/3rd of What You Earn
Try reading these posts:
- Here Are The Best Laptops For Traders
- If You Have To Use A Card, Here Are The Best Ones For Travel
- Sometimes, You Have To Force Yourself To Save
- Yes, You Can Live Off The Interest On $1 Million Dollars
Adam Woods is a physicist. His research interests include building software to run and build geomagnetic models. Adam got interested in personal finance in the great recession when it became obvious an interest was necessary.
After harassing his friends and family (and a short intervention) he took to the web where he blogs about finance, investment, politics, and economics.
Adam is currently located in Boulder, Colorado where he can generally be found hiking, biking, or running a D&D campaign. He can also be contacted at adamwoods137@gmail.com.
Considering different ways to THINK about the way we spend is my new favorite. We’re still struggling out of credit card debt, but I’m hopeful we can destroy it this year. Last year was our #yearofno, and this January was a struggle to convince our brains that we needed to continue the job. But now I think we’re back on track. When I have temptation to spend next, I’m going to remember your 3X theory.
Fantastic to hear! As I said above this is *really hard*, but thankfully what to do is obvious.
Every young person should be required to read this article when they get their first credit card. My husband laughs at me and my reward cards and sign up bonuses but we both agree that if we can’t afford it, we don’t buy it.
Sometimes I wonder about myself and credit card bonuses/awards. The only method I’ve come up with is mint to keep careful track of my spending. Fortunately I’ve managed to keep my spending in the only buy what you can afford bucket.
It took me years to learn this straight-forward “simple hard” lesson. Now I pay off my cards in full every month and reap the rewards and bonuses. I agree with RAnn, every young person should consider this required reading when they get their first credit card.
The rewards are worth a lot, just not as much as the interest. If there were two bits of information I wish I could get to young people, it’d be don’t pay interest on credit cards, and don’t pay interest on cars. There’s plenty of time later for a nice car.
I liked that 1/3 rule, and should try to follow it more often. I use a credit card for everything because cash seems to disappear without a trace, and at least there is a statement for credit card. I also try to calculate how many hours I have to work to pay for something before I swipe my credit card.
I have the exact same problem with cash! I think it’s inverted from the previous generation, but the pieces of paper just don’t *feel* like real money to me.
This is a terrific rule and I love the logic behind it! It’s so true everyone is looking for the easy complex way out of bad situations and those ways never work.
Frankly, I *love* easy-complex solutions, most of modern life is easy-complex solutions. Computers are a great example! The major problem in my view is that complexity can let bad actors hide their intentions, and it’s particularly bad in areas that people have a lot of personal control/investment in.
Never heard of this rule before–but I love it! So true that simple and hard is almost always more effective than complex and “easy”.
I can’t take credit, I believe I originally heard the concept from Jacob over at Early Retirement Extreme.