A guaranteed 18% return on your investment! Sounds too good to be true, right? Well, it’s not, you can actually get a huge guaranteed return on your money by doing one simple thing: paying off your credit card debt. Paying down a credit card balance doesn’t sound as exciting as putting your money into a hot stock that will return 18% year after year, it sounds like a boring and hard thing to do with your money. But paying off high interest debt, should be just as exciting as investing in that hot stock; the return on your investment is the same, and the math works. 18% is the return on investment that the average American in credit card debt can achieve, just from paying down their revolving credit card balance.
CREDIT CARD DEBT STATISTICS
According to a 2019 study by Nerd Wallet, credit card debt that is carried over month to month (revolving debt) in the US has reached $423.8 billion. The average household with revolving credit card debt has an outstanding balance of $6,741.
The average credit card interest rate is approximately 18%, and can often be well over 20%. The interest rate is called the APR (annual percentage rate) and is the percentage of your outstanding balance that you pay in interest each year. To figure your monthly interest rate, just divide your APR by 12. That’s how much interest you are being charged each month. So for a credit card with the average APR of 18%, the credit card company is charging you 1.5% interest on your total balance every month.
THE TRAP OF MINIMUM PAYMENTS
Credit card companies make debt seem manageable by only requiring you to make a very small monthly minimum payment, it is different for each card but the minimum payment is usually around 1-3% of your outstanding balance.
Think about this…we just said that with the average 18% APR credit card, you are being charged 1.5% interest on your balance every single month. Now, the credit card company is telling you that you only have to make a monthly payment of 3% of your balance. You don’t need a calculator to tell you that it is going to take a really long time to pay off your debt, and that you’ll end up paying loads of interest along the way. Just play around with a credit card payment calculator to see how much you could end up paying, and how long it will take to pay off your debt.
Example: Making a 3% minimum monthly payment on a $6,000 balance for a credit card with an 18% APR will take 178 months to pay off. That’s almost 15 years! Over that period of time, you’ll also end up paying $5,497 in interest. Yikes!
CREDIT CARD DEBT PAYMENT AS AN INVESTMENT
Credit card debt absolutely sucks the life out of your finances. This is because every dollar you owe on your credit card has a negative 18% return every year, as long as you carry a credit card balance. A guaranteed negative 18% return on your money is a huge drag on your finances, and it should seem like an unacceptably terrible return on investment to any reasonable person.
FLIPPING THE NUMBERS
The problem is that we don’t see credit card debt for what it is. Because it is so common to carry a credit card balance, we start to see it as something that is normal and acceptable. It is not normal, and it is not an acceptable financial position to be in. In order to see how bad credit card debt is, we just need to change the way we look at the numbers.
Imagine that you heard about a new and exciting investment opportunity that would guarantee you an 18% return on your money year after year. Most people would jump at the chance to make that kind of return, and I bet that even people with credit card debt would be able to come up with a few hundred dollars to throw into an investment opportunity like that.
But the reality is, that every dollar spent toward paying down your credit card balance DOES earn an annual return equal to your interest rate! It’s pretty much impossible to make that big of a guaranteed investment return in any other way. Think of each dollar you put toward your credit card as a dollar that is invested, and is making a ridiculously high rate of return, about 18% on average…and that’s a guaranteed return too.
On the flip side, you’re getting a negative 18% return on every dollar you spend on anything other than your credit card balance. If you are going to put your money toward something other than your credit card bill, it better be an investment making more than 18%, and that’s the return you’d need to make just to break even with the money you are losing by not paying off your balance.
If you eliminate a dollar that is costing you 18%, it has the same effect on you net worth as if you were investing a dollar that will be making an 18% return. So invest every dollar you can into reducing your credit card debt, and you can feel like a genius who found a way to make a guaranteed 18% return on your investment.
OTHER BENEFITS OF PAYING CREDIT CARD DEBT
The obvious benefit of paying off your credit card is that you will get out of debt and won’t be paying loads of money in interest. But there are other benefits to paying off your credit card debt too.
YOUR CREDIT SCORE
Too much debt, especially credit card debt, has a negative impact on your credit score. Paying down debt will reduce your credit utilization ratio (the percentage of your total available credit that you are currently using). Keeping your credit utilization low will help to improve your credit score. Your credit score is an important part of your overall financial picture, and you should do everything you can to maximize your credit score. Having a good credit score will help you qualify for the best interest rate on any credit you may apply for in the future (like a mortgage).
YOUR INVESTMENT RETURNS
You will also improve your overall investment returns by paying down high interest debt. If you are going to be honest with yourself about your finances, that negative 18% return you are getting on your credit card balance has to be considered. The negative 18% drag on your investment returns makes it almost impossible to make any meaningful progress toward meeting your financial goals until you eliminate your high interest debt.
Example: If you have a 401(k) with $10,000 invested and you see that your account made a 12% return last year, don’t be too quick to think that you are truly getting a 12% return on your investments. Your real return could be significantly less depending on how much interest you are paying on your credit card.
Remember that every dollar you owe on your credit card is costing you 18% annually. So if you have a $6,000 revolving credit card balance with an 18% APR, your real overall return on your 401(k) investment will be reduced to approximately 1%. Talk about a drag on your investment returns!
YOUR NET WORTH
Finally, don’t forget that reducing your outstanding credit card balance will also increase your net worth. Credit card debt is a negative number on your net worth statement. Getting rid of negative numbers on your net worth statement is the same as adding positive numbers. So, from a net worth perspective, paying off a credit card is just the same as traditional saving and investing…except you get a much, much better return on your investment.