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Some people are big believers in credit cards while others won’t go anywhere near them. 

There are definitely benefits to having a credit card – if used correctly – but there are also things to be wary of. It’s especially important to not just pay the minimum monthly repayment if you do have a credit card.

 

Benefits of a credit card 💳

By using a credit card and always keeping up with repayments, you can show that you’re a trustworthy borrower. This can be really useful when it comes to buying a house with a mortgage or making other big purchases for which you’ll need to borrow money.

A mortgage is a huge loan so a lender wants to know they’ll get their money back before lending to you. A history of using a credit card responsibly means you’ll have some evidence of this. 😌

Also, credit cards reward you for your spending. Whether through a points system, cashback or something else, just by spending money you can earn rewards.

But don’t fall into the trap of chasing rewards! ⚠ Credit card rewards are only worth it if you’re spending money you would spend whether there were rewards on offer or not. If you normally pay for shopping, presents, transport and eating out on a debit card, it makes sense to switch this spending to a credit card and get rewarded for it.

Chasing the rewards, lots of people end up spending more money on their credit card than they would usually spend – which can mean they actually spend more than they earn from the rewards! 🤦

 

Options you have for paying off a credit card

When using a credit card, you pay for things upfront using the card and the bank’s money and you’ll then have to make monthly repayments from a current account – the money is taken out of the current account each month by Direct Debit. You have three choices of how much to pay each month:

  1. Pay off the amount owed in full. This means you won’t be charged any interest.
  2. Pay the minimum monthly repayment. This might be a fixed number or a percentage of the amount owed.
  3. Pay an amount of your choice that’s between the minimum monthly repayment and the full amount owed.

If you can, always pay off what’s owed in full – if you don’t, you’ll be charged interest so you’ll pay back more than was borrowed in the first place. Choosing to pay only the minimum amount can be a really bad idea.

 

Why paying just the minimum on your credit card isn’t good 🙅

Imagine you owe £500 on a credit card (this is called your outstanding balance) and the annual interest rate (the APR – Annual Percentage Rate) is 30%. If the minimum monthly repayment is £25 and you only pay this, even if you never spend any more on the card:

  • It will take 27 months to pay off all the debt on the credit card
  • You’ll end up paying back £667 in total, meaning you’ll pay £167 in interest

By only paying back the minimum each month, you end up paying back over 30% more than you borrowed. And it gets worse if you borrow more money.

 

If you owe £1,000, the interest rate is 30% and you only pay the minimum monthly repayment of £25:

  • It will take 99 months to pay off the debt – that’s over 8 years!
  • The total amount you’ll pay back will be £2,464 – meaning you’ll pay £1,464 in interest!

So the interest alone is more than what was borrowed in the first place.

 

What’s the best way to pay off credit card debt?

It’s best to only take out a credit card if you’ll be able to pay off the outstanding balance in full every month. This way, you won’t be charged any interest so you’ll only end up paying back exactly what was spent.

If you’ve got a lot of debt, it might not be possible to pay off the outstanding balance in full. But still try to pay back more than just the minimum monthly repayment to reduce the amount of interest you’ll pay overall and the time it takes to pay it all back.

In the second example above, even if monthly repayments are increased by just £10 a month to £35, you’ll pay around £900 less in interest and the debt will be paid off in under 4 years. 🤯

When trying to pay off debt on a credit card, first make sure you’ve made a budget and put money aside for all necessities, including rent, bills and food. Once these are covered, try to dedicate as much money as possible each month to paying off your credit card debt.

Having debts will mean constantly having to pay out more and more money in interest, which will really hold you back with your financial wellbeing. Paying the minimum on a credit card might be the easiest option, but it will be the most costly (both for your wallet and wellbeing) in the long run. ❌

 

We’ll be speaking lots more about managing and overcoming debts in week 2 of the Student Festival of Financial Wellbeing, including some of the main ways people use to pay off debts.

Don’t forget to sign up for the free financial education webinars included in the Festival.

 

Further learning

Paying off debt: Snowball or Avalanche method?

Credit score pathway

The rise (and risks) of Buy Now Pay Later

Crypto 101

3 finance questions you are too embarrassed to ask