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Compound Interest

January 29, 2020

The magic of compound interest is something that is well known to investors, and the frequency of compounding can add significantly to an investor’s portfolio.  If you invested $200 per month for one year with an annual compounding of interest after two years you would have saved $4,920 but if the interest compounded monthly, you would have $5,037.18 saved.

As you can see the compounding of interest works for you when you are investing by adding interest onto interest, but it does the opposite when you are the debtor.  Some credit card issuers compound interest monthly and the effect on your pocketbook is staggering, especially when interest rates are commonly around 29% and minimum monthly payments only 2.04% of the outstanding balance.

If you owed $10,000 on a credit card, following the assumptions above, after two years you would have paid over $6,000 in interest and seen no significant, if any, reduction in the amount of debt owed.  This explains why you will notice on credit card statements the indication that it will take hundreds of years to repay the debt using minimum monthly payments.

Although Canada is a very bureaucratic country and has many laws, there are precious few to protect consumers from exploitative lending practices.  When using credit cards, it is wise to always, at the very least, pay off the full statement balance each month.   Paying the statement balance is not the same as paying the debt in full.  The statement date may be the 15th of the month while the payment due date is the 27th – by the time you have paid the full statement balance you may already have significant debt on the card.