We are all about partnerships at Momentum. We know that we cannot do everything and that many of the people in our community have knowledge and expertise that we can learn from. It is in the spirit of learning from our community members that we present the following blog post from guest blogger Douglas Hoyes, Founder & Trustee of Hoyes, Michalos & Associates.
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Most people work very hard to keep up with their bill payments. However, paying only the amount at the bottom of the statement may not be in your best interest.
If you are paying your full car loan or mortgage payment every month, in full and on time, that is good. These types of payments have a fixed payment schedule. The amount due each month is designed to pay off your loan over a fixed term, the length of time you agreed to pay off the loan up front. If you signed up for a five year car loan, as long as you make all your payments, your loan will be gone in five years.
Beware the Minimum Payment Cycle
Things like credit cards and lines of credit, however, work quite differently. Financial institutions don’t design your payments to make sure you get out of debt sooner. Instead, payments are designed to cover interest and just a little bit more. The end result is that each month the bank keeps charging you interest on almost the same amount of principal, which means it becomes very difficult to get out of credit card debt if you carry large balances.
Let’s look at an example. Today you owe $7,000 on your credit card and that card charges 19% interest. The minimum payment amount, as set by your bank, is 3%. That means your statement will say that you owe a minimum of $210 this month. If you pay the $210, your account is current – so that’s good. However, the interest that accumulated on your $7,000 balance that month was $110. So really, you only paid $99 toward the principal amount; next month, you still owe $6,901. If you keep doing this, it will take almost 22 years to pay off your credit card debt.
Don’t Spend More Than You Pay Off
Now, let’s say you are continuing to use that same credit card and you spent $150 on your card that month. Instead of paying down any debt, you owe $7,051 at the end of the month; more than you owed at the beginning of the month. Continuing to use a credit card while paying off only a small amount is the number one reason people suddenly find themselves with more debt than they can handle.
If you are paying less than the full payment each month, try this credit card debt repayment calculator to see how long it will take you to pay off your debt.
Avoid Borrowing From Other Sources
In addition to making sure that you are not continuing to charge more than you are paying off each month, it’s also important that you are not just juggling payments to keep up. If you are often doing things like taking out a payday loan to pay your rent or meet your car loan payment, you are fighting a losing battle. Let’s say you borrow $1,200 for two weeks from a payday lender to pay the rent and buy a few groceries, depending on the province you live in, when it comes time to pay back your loan, you will have to pay back around $1,450 (give or take). That’s just like losing $250. Can you afford that very often?
My recommendation is that when you make your bill payments each month, take a look at the total amount of debt you still owe and make sure the debt levels are declining, like they should. If they are not and you are concerned, talk to a credit counsellor or bankruptcy trustee about ways they can help you get out of debt sooner.
About the Author
Doug Hoyes has extensive experience resolving financial issues for Canadian citizens. A Licensed Bankruptcy Trustee and co-founder of Hoyes, Michalos & Associates, he is also a Chartered Professional Accountant (CPA), Chartered Insolvency and Restructuring Professional and Business Valuator. He regularly comments on a variety of TV, radio and other media outlets on topics surrounding bankruptcy and writes a column for the Huffington Post. Hoyes has been a Licensed Trustee since 1995 and has testified before the Canadian Senate’s Banking, Trade and Commerce Committee in 2008.