Anytime you speak to someone about applying for a credit card, the usual warning is “be careful, you could get stuck paying it back for a long time.” While this may have some truth to it, the payback duration is often exaggerated considerably by credit card companies and financial analysts. For instance, if you visit any credit card repayment calculator website and input an AED 10,000 balance, a 4 percent minimum payment and a 20 percent interest rate (the average rate according to bayzat.com is currently aorund 34%), it will take over 14 years to pay back the balance and cost about AED 7,000 in interest.
How Repayments Really Work?
In the above example, the reason it takes so long to pay off the credit card balance is because the monthly payment is calculated as a percentage of the total outstanding credit card debt. So if the minimum monthly payment is 4%, then that equals AED 400 for an AED 10,000 balance. However, as it is paid off, the balance reduces; so for example, if the amount owed after 12 months is AED 7,713, the minimum payment that month would be AED 309. This is why getting to a zero balance takes so long. Below is a chart to illustrate the data:
However, as a cardholder, you should be making the same fixed payment each month depending on your budget. So if you were to pay AED 400 each month, rather than the minimum payment of 4% of your balance, it would actually take about 3 years to pay off your credit card debt.
Balance Transfer Cards
Taking advantage of a balance transfer offer is a great way to pay off a credit card sooner (to find out more, read our article on balance transfer credit cards by clicking here). Typically, the first few months after transferring your balance will be interest free, for example, a bank may offer you 0 percent interest for the first 6 months. In this case, we will use 3 percent balance transfer fee (this is the fee charged on the amount transferred from your previous credit card).
Let’s take a look at what you save:
|Balance Transferred||AED 10,300|
|Monthly Payment||AED 400|
|Interest Rate After Transfer||20%|
|Months to Repay||31|
|Total Interest Cost||AED 1,762|
In addition to paying off the credit card sooner, you also save about AED 1,300 in interest payments.
A personal loan can also be taken to pay off your credit card debt, which means you are essentially replacing the high-interest credit card with a lower rate from the personal loan. Assuming a 10% interest rate on the loan, and an AED 400 monthly payment, the personal loan can be paid off in 28 months. This strategy provides almost the same amount of savings in interest payments as the balance transfer; even though the interest rate is lower for a personal loan, there is a 0% interest period with the balance transfer card.