The real cost of borrowing
I paid my credit card every single month for two years. Then I checked the balance. It had barely moved.
In Level 3 you saw how interest helps your savings grow. Debt works the same way, but against you. Interest is added to what you owe, and then you’re charged interest on that interest too.
Borrow 1,000 at 20% a year and pay nothing back:
- After 1 year you owe 1,200
- After 2 years you owe 1,440, not 1,400, because the second year’s interest is charged on 1,200
The minimum payment trap
Lenders set a minimum payment that’s small enough to feel easy. That’s exactly the problem. Most of it goes on interest, so the amount you actually owe shrinks very slowly.
Say you owe 100,000 on a credit card at 24% APR, and you only pay the minimum each month (3% of the balance, but at least 2,000):
| How you pay | Time to clear it | Interest paid |
|---|---|---|
| Minimum payment only | About 7 years 10 months | About 107,000 |
| A fixed 5,000 a month | About 2 years 2 months | About 29,000 |
| A fixed 10,000 a month | About 1 year | About 12,700 |
Paying only the minimum, you’d pay back more in interest than you borrowed, and it would take almost eight years.
Same debt, same card. The only difference is how much I paid each month. That table is why I stopped paying the minimum.
How to pay less interest
- Pay more than the minimum, even a little. Every extra amount goes straight to the principal.
- Pay a fixed amount, not a shrinking minimum. As your balance falls, keep paying the same amount.
- Pay on time, every time. Late payments add fees, and they can add a higher interest rate too.
- Stop adding to it. It’s hard to empty a bucket that’s still being filled.
