The way you use credit cards can affect your retirement planning and retirement savings. The improper use of plastic can actually undermine your ability to save and invest for retirement. Therefore one of your first steps in retirement planning must be to examine your credit-card use and revise it if necessary.
The reason that credit cards can imperil your ability to save for retirement is obvious. If you accumulate a lot of credit-card debt a large portion of your income will end up going to interest payments. Instead of investing your extra money you will end up sending to card companies every month. The reason many people cannot save for retirement is that all of their extra income is going to card interest.
That means you should know how credit-card interest and debt builds up in order to prevent it from accumulating. The way it works may surprise you even though it is actually pretty obvious even to lay people.
How Credit Card Interest Compounds
Credit cards like a number of other consumer loans are designed to take advantage of the principle of compound interest. In compound interest the interest is added to the principle of an investment to increase it. Unfortunately interest can also be compounded into the principal of a loan to increase it. That’s how most card plans work the interest is compounded into the balance to increase what you owe.
Here’s how it usually works: Doogie has a credit card with 19% APR (interest) and an $8,000 balance. That means that he would owe $1,520 in interest every year and $15,200 over ten years. If he paid the minimum payment of around $160 a month it would Doogie about 94 months around eight years to pay the debt off. He’d end up paying $6,897.89 in interest or a total of $14,897.89.
Obviously Doogie would have a hard time saving for retirement while he’s paying off those interest payments. If he had more credit card debt he’d have even a harder time. This means that you must start controlling your credit card debt if you want to be able to save for retirement.
Controlling Credit Card Debt
Controlling your credit card debt is actually easier than you might think. The best and most-effective method is to simply stop using plastic or limit its use. Some experts recommend cutting up your cards.
Another method you can try is the drawer plan. Simply put your credit cards in the drawer until you’ve paid off the balance. That way they will be available for emergencies but they won’t be in your pocket or purse to serve as a temptation. Not carrying the cards teaches you not to rely on them and not to use them. Instead you can use a debit card or cash. Studies indicate that people who spend cash actually spend less. Relying on checks can help too because the hassle you have in spending the less likely you are to spend.
Another way to control card expenditures is to start paying the balance off each month. That gets you to think about what you spend and it keeps you from compounding interest. The advantage to his is that you still have access to the cards and their advantages but you are limiting what is accumulating.
A good way to begin controlling credit card debt is to try and pay as much of it off as possible. Never use all of your savings for this purpose because that will put you in a situation where you will have to use the cards if you face emergency expenditures. If you have a lot of savings or funds in investments consider using part of it to pay off credit card balances. Another method to consider is using a home or real estate equity loan to pay off the plastic debts because the interest on it is cheaper.
The moral of the story is that you will have a much harder time saving and investing for retirement if you have a lot of credit card debt. Paying it off and not accumulating anymore is one of the first steps in ensuring a secure retirement.