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Your credit card interest rate doesn’t matter

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Ok, I’ve gotten some heat for this idea, but I don’t care. I’m tired of hearing people bragging about their credit card’s low interest rate. Here’s why I don’t care whether it’s 5% or 80%.

What does “interest rate” mean on a credit card?
A credit card basically gives you a short loan for the month. If you pay it off completely during that monthly period, you don’t pay for the loan–it’s an interest-free loan.

But if you don’t pay off the entire balance–let’s say you spend $1,000 on your credit card but can only pay off $500 that month–then you have a balance on your card. That’s what interest is charged on; typically, it’s somewhere around 20%. In this case, you’d be charged $8.33 that month ($500 balance * 20% interest) / (12 months).

Why I don’t care if my CC interest rate is 5% or 80%
It’s simple: I never carry a balance–and neither should you. If can’t pay it off at the end of the month, I don’t buy it.

I’m not going to belabor the point because, if you’re reading this, you clearly care about your money. But you would be shocked how many people I talk to that charge purchases without knowing how much they’ll actually pay for it. So let’s take a look…

Let’s say you have a $10,000 balance on your credit card and you pay the minimum amount, which is around $250 every month. How much will it actually cost you? The answer is shocking. Get ready!

If you only paid the minimum on your $10,000 balance, it would take you 452 months (over 8 years!) and cost you over $19,000–in interest alone. In other words, you’d pay around $30,000 for a $10,000 balance.

This is why credit card companies are so incredibly profitable, especially with young people who don’t know any better.

The point is pretty obvious. Don’t carry a balance (if you do, pay it off as quickly as you can). Pay the maximum every time. If you can’t pay off a purchase by the end of the month, don’t buy it. “But Ramit,” people say, “what about homes and college and cars? How can I pay that off in one month?” Yes, true, those very expensive purchases necessitate some kind of longer-term loan. But not with your credit card.

So when I hear people excited about their introductory interest rate (“It’s 0% for 6 months!!”), I’m not really impressed. As long as you pay your balance in full every month, your CC interest rate is meaningless.

References

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19 Comments

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  1. All I ever think when I get these offers in the mail is: WHY WOULD YOU EVER CARRY A BALANCE ON YOUR CREDIT CARD!? (Thank you for yelling on my behalf.) I don’t even know the interest rates on any of the credit cards I’ve ever held.

    The only time it is at all relevant is when you play games with a super-low (0%) interest rate on a very high-limit card. Some people with balls and money to back them up use these offers to invest aggressively over 6-12 month windows. Even if you only do something super-low-risk so you can easily guarantee your ability to pay it off, this is the one time a credit card really does give you “free money.”

  2. I admire your discipline and agree with your advice.

    However….

    …my cynicism provokes me to say (perhaps controversially) that the fact you are a student at Stanford gives you more flexibility in managing your finances than other students.

    I have recently paid of an outstanding balance of two years and just feel such complete relief. There have been times when I have had to suddenly put large costs on my card – such as car insurance changes, travel costs, suit for graduation interviews etc. Sometimes the money just isn’t there when it has to be!

    You don’t have to have the shopping habits of Karyn Bosnak in order to find yourself short of cash.

  3. You’re correct in saying that interest rates do not matter if you pay off the ballance every month but check your statement on how interst is calculated. It is not calculated on the balance remaining after your payment.

    My name is Roque Curiel, I used to teach personal financial management at the university level and I am the author of the textbook, “Money Well Spent.”

    I admire your mission and I think I understand the point of chossing the title you have for your blog. I teach people to achieve financial independence, which is a different state of mind than rich, altogether. There are rich people going bankrupt everyday. FI is a a condition of enough to meet your needs; sadly, rich is a distorted vision of a certain level of consumption (usually) that some people carry around in their heads.

  4. Roque, you’re right about the interest accruing on each purchase the month after you have a running balance. Thanks for pointing that out.

  5. Some credit cards use the nefarious two-cycle daily balance, which keeps you paying interest on half of what you’ve paid off for a FULL MONTH after you make your payment. Watch out for this trap!

  6. Well, I don’t agree with you 100% on not carrying a balance, that’s a lifestyle choice.

    On a side note, this is what I use my 0% CC’s for is this:

    Get one that gives you a year at 0%. Then ‘pay-off’ another CC. When I say pay-off, I mean pay it to another card with no balance. Then have that other card cut you a refund check. Then use that refund check to put it into an investment, like INGdirect.com. Then make ~$100 month off of interest alone, for doing VERY LITTLE.

  7. Hi Roque,

    What a small world !, My name is Roque Curiel also. We share many financial credos. I refuse to carry a balance on our two credit cards and actually get 1% cash back on our Golden 1 Visa card.
    I bought your book from Lulu.com but it looks like the printing was not complete, I did not get the seven steps to financial freedom, the book ended abruptly. My wife was surprised when she read the book, she thought that most of the ideas related to my way of thinking, except for the deep quotes. Anyway, we are a family of four with a mortgage of $1506.00 per month and a second (swimming pool) of $467.00 per month. our income is about $105,000 pretax and we have a couple of retirement and colllege funds (Retirement is payed by our employers, college fund is $100.00 per month). We have about $300,000 equity in our house and plan to stay here for quite a while. Any suggestions ????.

  8. Ah, but if your credit card offers a fixed rate balance transfer that is lower than the interest rate of your current student, business or car loan, and you don’t use that card for anything else, it can be quite economically smart to carry the balance there rather than with the higher rate lender. For example, we took out a small business loan which I transferred to a credit card at 2.9% fixed. I don’t use the card at all. Just make the biggest payments we can every month. We did the same thing with our car loan and the balance on my student loan. Because you can’t beat a 2.9% fixed APR.

  9. Marnell Bookins Link to this comment

    Run these numbers, pay 50% of a credit card balance each month for 6 months or less, calculate the actual real rate of interest.

  10. I carry a 30% balance on my cc. This is a strategy I am using for building credit. It is a low limit card, that I use only for already budgeted monthly expenses. I do not care what the interest rate is, because the credit it is building for me will allow me to make many times that amount. Credit is like a muscle- use it or lose it. Use it wisely, and it can be an invaluable tool to financial freedom.

    • Actually you don’t need to carry a credit to build your credit. You are wrong about that. The other guy commenting, Roque. I can’t believe you wrote a book on financial freedom and you can’t even spell balance. Go figure…

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