On the Finance team at my job, I'm the one that's constantly asking questions. I don't just know the answers. I studied English. Give me a poem and I'll explicate it. Financial planning is something I'm learning. I had a moment where I was talking to a co-worker and she had a question about a bill and hoped I would have answers. I hope I satisfied her curiosity, but the interaction made me want to share a bit about credit cards. I mean, I've shared before. I talked briefly about earning an annual percentage yield instead of owing an annual percentage rate. But I wanted to delve a bit deeper. I wanted to help make it clear that banks and credit cards are in it for the money.
I have a Target Red card. I love that thing. It has bailed me out so many times. The thing about my first purchase was I was really excited about that 5% discount. You get a certain amount at the register and when you use your card, the payment amount drops by 5%. Now my card has an interest rate of 24.15%, so that little discount is closer to 19.15% that I pay them, and if we ignore the fact that you pay on something that's compounded and are discounted on something that is not.
Interest Rate Basics
If you look at your bank's account snap shot, you won't see your interest rate. In fact, the only way I've ever found it was to pull up the PDF version of my statement, and look at the very last page of the statement. This is where you'll find your interest rate, as well as interest and fees that have been charged.
Einstein's Rule of 72
I learned something new and I wanted to share it. The rule of 72 teaches us that if you divide 72 by your interest rate, your answer is the amount of years it'll take to double the money. My bank has an annual percentage yield of .25%. If I put $100 in savings, I can calculate 72 divided by .25 and it'll give me 288. So in 288 years, my $100 investment will be $200. It's time to look for a higher interest rate and that looks like mutual funds for me. But that rule can help understand your debt too. Let's assume that Target Red Card has a balance of $100. 72 divided by 24.15% means in 2.98 years, I'll owe Target $200. This is assuming I don't make any more purchases and I don't pay it off sooner. The rule works the same. Whether that rule is putting money in your account, or taking it out is up to you. It seems shady because it is. Most statements include a section that tells you how long it'll take you to pay off the card by paying the minimum due. The minimum will generally go to the interest they are owed and less than half of the rest of the payment goes toward the amount they charge in interest. You pay them first, so it'll be a while before smaller payments make your balance go down.
Having more is about spending less
If I make $59,000 a year, but at the end of the year I have $500 in savings, did I actually make what my w-2 says I did? I wasn't paying myself or my kids. I was paying everyone else. Don't get me wrong, I'm actually pretty frugal. My team was taking me out for my birthday. My choice. I wanted to go to Hillstone and spent the week looking at the menu and eyeing a $40 steak. I would never spend that much on my own steak. A meal is only a memory once you're done chewing and I don't like to spend a lot on food. I was unable to get the steak. I couldn't do it. I had the full blessing of our CFO and Controller, but I couldn't waste the money, even if it wasn't mine. And yet, there's still room to squeeze what I spend.
How about we squeeze a little cash out of the budget. On my splurge days, I might get Tender Greens for lunch. On a low key splurge, that will be either a $5 soup or a $6.50 kids meal. On other days I might want a Venti Vanilla Bean Steamer or a Cafe Misto from Starbucks. These are treat days. These are moments when I want the comfort and familiarity of a Starbucks. I get a super sweet drink with over roasted beans and it feels good. If I were to only get this during the week while I'm at work and to keep it simple and round it down, lets say it was $5 for Tender Greens and $5 for Starbucks. What if I took the money I would give them and give it to myself instead. I just saved $50 a week or $200 a month. Again, banks make their money off of your money and what about ATM fees. One day I used a Wells Fargo ATM and I checked my balance before taking out cash. The next day I was balancing my checkbook and there were two fees from Wells Fargo and one from my bank. I swiped my card once. I entered my pin once. The fees were taken because I had two transactions and my bank was kind enough to waive one of those fees, but let me know I'm better off looking for one of our ATM's next time. Believe me, I do now.
Debt rollups were once a payment plan where you aggressively pay off your largest debt. Or maybe you focused on the one with the highest interest rate. I've recently learned something new, and I'm doing it as a hybrid of what I was taught and what makes the most sense for me.
As I explained above, credit cards will request a minimum payment due but these payments often have more than half of the minimum due going to the interest they're charging. A tiny amount goes to paying down your debt. When I pay the minimum, it's the minimum due, plus the interest that was just charged.
The idea is to rollup your debt and one by one, aggressively pay off your debt. I'll try to keep it simple. I'm leaving out the interest paid that I want to right away cover in my next minimum payments. Let's say we have three cards as outlined below.
Target $800 with a minimum due of $40
Victoria's Secret $500 with a minimum due of $25
Zales for $700 with a minimum due of $50
Based on minimum amounts due, I can get by with paying $115 a month without hurting my credit scores. I want to pay off the lowest balance first, so I'm focusing on Victoria's Secret. I am already paying that card $25 a month, but I've cut out Tender Greens and Starbucks, giving me an extra $100 a month. If I focus on $125 a month to pay off this $500 balance, it's going to roughly take me only 4 months. At the end of that 4 months, I can focus on my next card, Zales.
If I now have that $125 to add to the $50 I was paying, I now have $175 to pay towards Zales each month. If that balance was still at $700 a month when I started paying it off, it would take roughly another 4 months to pay it off.
Add the $175 I was putting toward Zales to the $40 I was already paying Target and I can now dedicate $215 a month to paying off Target. That last card will take less than 3 months. I will have paid off 3 cards in less than a year, and $2,000. If instead of owing $2,000, I was saving that money, I could confidently say that this amount I made is also the amount I get to keep and if I actually invest it, I can watch it grow. Imagine saving $215 a month. In 12 months, I've set aside $2,580. I know it's easy to see that as a couple of iPhone X's, but it's also a vacation to Greece.
It's easy to get into debt and getting out of it can be hard, but it's totally possible.