Let’s look at this for a moment and at the risk of simplifying the calculation, I have used a flat tax rate to help get the point across. Say the interest rate for a credit card was promoted as being cheap at 15 per cent. The money you earn at work arrives in your bank account after your employer has taken your income tax out. Say your tax rate is 30 per cent, to find the real cost of the credit card interest, you need to add it to your tax rate, so the actual cost you are paying is 45 per cent! See below for more examples:
|
Your income tax rate |
Credit card interest rate | Interest paid on a $1000 credit card loan | Total real cost of paying interest on your credit card |
Total real cost of paying interest on $1000 credit card loan |
|
20% |
15% | $150 | 35% |
$350 |
|
30% |
15% | $150 | 45% |
$450 |
|
45% |
15% | $150 | 60% |
$600 |
Another way of looking at this is: to receive an income of $1 after paying 30 per cent tax, your gross income needs to be $1.43. Therefore, the tax you would have paid to receive the $1 is 43 cents. Say you had to pay $1 in credit card interest. This then brings the total cost (tax and credit card interest) to $1.43 not just $1. For more examples check out the table below:
|
Your income tax rate |
Income received after tax | Tax paid to earn that $1 | Interest paid | Total real cost to pay $1 of interest |
Total cost if you paid $100 in credit card interest |
|
20% |
$1 | 0.25 | $1 | $1.25 |
$125 |
|
30% |
$1 | 0.43 | $1 | $1.43 |
$143 |
|
45% |
$1 | 0.82 | $1 | $1.82 |
$182 |
It doesn’t matter how you slice and dice it, you can see once you look at the real cost and do the maths, it is actually expensive debt and it is actually NOT OK!
If your next thought is, “but I just can’t seem to survive without my credit card”, then I strongly suggest that you read the section on “Practical Management of Your Money” and implement every single one of the ideas, even if you don’t believe right now that any of them would work for you. This section is available in the book, Mindful Money. Grab a copy now and kick start your financial future.