Credit cards are convenient tools for daily transactions, but carrying a balance can be extremely expensive due to high interest rates. Unlike fixed-rate personal loans, credit card interest compounds daily, which can lead to rapid debt growth if you only make minimum monthly payments.
Credit cards calculate interest using a Daily Balance Method: - **Daily Rate:** Annual Percentage Rate (APR) divided by 365. - **Daily Interest:** Your daily balance multiplied by the daily rate. - This daily interest is added back to your balance at the end of each billing cycle, compounding monthly.
Credit card minimum payments are typically calculated as a small percentage of the balance (e.g. interest plus 1% of the principal). Because this payment is so low: - The majority of the payment goes toward interest. - The principal decreases very slowly, extending your payoff timeline by decades and costing you thousands of dollars in interest.
To calculate payoffs across multiple credit cards, see our multiple credit cards payoff tracker or check our general debt payoff planner.
To eliminate credit card debt efficiently: - Pay More Than the Minimum: Even small extra payments directly reduce the principal balance, saving interest. - Debt Consolidation: Replacing high-interest credit card debt with a lower-interest personal loan. To check consolidated rates, see our debt consolidation tool.
To check how interest rates are calculated across different financial products, try our interest rate finder or see our payment calculator.
Suppose you owe $5,000 on a card with a 20% APR: - If you pay only the minimum (starting at $125/month), it will take over 15 years to pay off, costing approximately $5,800 in interest. - If you make a fixed payment of $200 each month: - You will pay off the balance in exactly 32 months. - You will pay approximately $1,450 in interest, saving over $4,350.
Eliminating high-interest debt immediately increases your household savings rate, allowing you to allocate more money to your emergency funds and investments.
Reducing your DTI ratio by paying off debt is key to maintaining a healthy financial profile. It improves your credit score and increases your future borrowing capacity for assets.
Card interest is commonly based on an average daily balance, so the date of a purchase or payment can affect the charge. Paying the statement balance by the due date usually preserves the purchase grace period, whereas carrying part of it may cause new purchases to accrue interest immediately. Cash advances and balance transfers can have separate rates, fees, and no grace period at all. Use the APR and balance that apply to the transaction being modeled, then check the issuer's statement method before treating an estimate as an exact payoff quote.