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When you're carrying balances on a couple of credit cards, the monthly interest charges may not seem that bad. It's easy to dismiss it as a little bit extra you need to pay here and there.
Not everyone realizes just how expensive credit card interest can be. The sobering truth is that on average, Americans who make minimum payments will end up paying about $936 per year in interest charges. That's nearly $1,000 that could instead go toward a vacation, a down payment on a home, or a bigger savings account.
The numbers show that credit card debt is a serious and costly issue. Fortunately, there are also ways to reduce how much interest costs you.
The math behind credit card interest costs
We used the following data to calculate how much credit card interest costs Americans:
- The average credit card balance in 2020 is $5,897, according to average household debt numbers.
- The average credit card APR is 16.43% as of August 2020, according to the Federal Reserve.
We could just multiply $5,897 by 16.43%. With that method, annual interest charges total $968.88.
However, your credit card balance changes as you make payments. For a more accurate result, we need to factor in how the balance decreases each month.
Minimum payment amounts vary by card issuer, but they're usually between 1% and 3% of the balance (with a $25 or $35 minimum). We'll split the difference and go with a minimum payment of 2% every month. On a $5,897 balance, that's a payment of about $118 to start.
Assuming they don't rack up any more debt, consumers who make 2% minimum payments every month would pay $935.95 in credit card interest that year.
How to pay less credit card interest
Here's the most important tip for how to save on credit card interest: Pay more than the minimum.
When you do that, all the extra money you pay goes toward the principal. It's easiest to demonstrate with an example. Imagine you're right at the average with credit card debt. You owe $5,897, and your minimum payment is 2%. Let's look at the difference in interest payments if you paid 2% vs. doubling it to 4% per month.
If you pay 2% per month, your first payment would cost $117.94. Of that, $80.74 would go to interest and $37.20 toward the principal. After one year:
- You've paid $1,367.18 total.
- You've paid $431.23 off the principal and $935.95 in interest.
- You owe $5,465.76.
If you pay 4% per month, your first payment would cost $235.88. Of that, $80.74 would go to interest and $155.14 toward the principal. After one year:
- You've paid $2,454.86 total.
- You've paid $1,614.59 off the principal and $840.27 in interest.
- You owe $4,282.41.
By paying about $120 more per month, you'll save on interest and make much more progress on paying down your debt.
Save money by refinancing credit card debt
There are also a couple of financial tools you can use to refinance credit card debt. This helps you pay off debt more quickly and for less money.
You could look for a balance transfer credit card. With a balance transfer, you move your credit card debt to a new card with a lower interest rate. The best balance transfer cards offer a 0% intro APR on balance transfers, and many offer that promotional APR for over a year.
Keep in mind that it generally takes a good credit score (670 or higher) to qualify for a balance transfer card and that you'll usually have to pay a balance transfer fee.
Debt consolidation loans are another option. You won't get a 0% APR, but you could qualify for a lower APR than your credit cards charge. And it's possible to get approved for a loan with bad or average credit, although a lower score can affect the interest rate you're offered.
Considering how much interest costs, paying off credit card debt is one of the best ways to improve your financial situation. It takes time and work, but it will save you a lot of money in the long run.