Photo by wajakemek

Among my human resource work experiences, I’d have done a couple of investigations into bankruptcy cases. Bankruptcy due to credit card debts is the most common. It is amazing to see how a simple debt of a few thousand dollars can escalate into tens of thousands of dollars, and finally bankruptcy. It’s even more amazing to see that people don’t realize how credit card debts snowball until it is too late.

If you are a working adult, you are almost certain to have a credit card. I still remember how proud I was when I got my first credit card; the feeling of elation as I signed on my first credit card purchase. Thanks to a job well done by our advertising and marketing friends for credit cards companies, these are the ‘perks’ of owning a credit card:

• perceived increased purchasing power
• perceived increased in status
• perceived improvement in lifestyle

Note that these are perceived, not real benefits. Getting a credit card doesn’t mean you earn more; it only allows you to spend more. It’s a skewed perception which is screaming:

Buy! Buy! Buy! Don’t worry, buy now, pay later.

Before you go out there and spend like crazy with your new credit cards, I hope to show you that unwise usage of credit cards can lead to escalating debts and even bankruptcy in a matter of months.

CREDIT CARD COMPOUNDING INTEREST

Here’s how credit card works, using assumptions of common credit card rates of 2% monthly interest rate (24% per annum), and a minimum payment of %3 or $50, whichever is higher.

A nice friendly service provided by credit card companies is the minimum sum only payment. On the surface, it seems that you only need to pay very little money each month for an item worth thousands of dollars. Good deal? Let’s say you bought a new flashy iMac for $2000. The table below will show you the payment schedule based on minimum sum only.

It’s shown that you will take 72 month (6 years) to repay your debt of $2000. At the end, you would have paid $3638 in total for that laptop. That’s an additional $1638 (81.9%) of interest! The credit card company is making Warren Buffet returns off you!

A good portion of my income in my first few years of working life had contributed to such interest payments, because I didn’t pay the full outstanding credit balance each time. Back then, I even wondered where my money had gone! Now I know.

COMPOUND INTEREST TILL YOU’RE BANKRUPT

From my experiences with bankruptcy investigations, the following are common contributing factors which lead to bankruptcy by credit card debt:

• pays only minimum sum each month.
• uncontrolled spending.
• more than one credit card.

All these factors compound the problem as the debts are spread across a few statements, and you don’t see the full picture of debt amount.

The table below shows a typical spending pattern which leads to bankruptcy. With same initial spending of $2000, the incumbent pays only the minimum sum, AND he/she continued to spend in subsequent months. (Notice on the 4th onwards, spending stops once credit limit is hit).

If you have 5 credit cards, the combined debt is $30,555. By this time, the monthly minimum payment sum is $920 ($185 x 5 cards). Bear in mind that the interests continue to compound even after the credit card is suspended or canceled. Unless your monthly payments are able to reduce the principle plus interest of that month, your net debt continues to raise each month!

Those who were unable to adjust their expenses and service the minimum payments ended up filing for bankruptcy.

It’s amazing how a few thousand dollars debt, when poorly managed, can snowball into tens of thousands of dollars.

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