When you're buried in debt, making minimum monthly payments can be tempting - especially for those of us on a tight budget.
The trouble is that these minimum payments have a tendency to maximize debt.
Creditors usually allow cardholders to pay a small portion of their balance each month - typically 2-4 percent - without penalty. These minimum payments cover interest plus a little bit of the principal amount.
But as the principal slowly decreases with each payment, your minimum payment will decrease as well - meaning you're making less progress on lowering debt with each bill.
A recent Bankrate.com column explains it like this: Let's say you have a $50,000 debt with a 3 percent minimum. When you make your minimum payment of $1500 a month, it knocks down your principal to $49,500, which in turn decreases your next minimum payment to $1485.
After a year of making only minimum payments, your new minimum would be down to $1343. After five years, it would be $829 and in 10 years it would be just $454. As your minimum shrinks, so does the bite you take out of debt with each payment.
At this rate, it would take 42 years to pay off that $50K balance - and your total payment would be $99,336, or nearly twice your debt!
By simply continuing to pay the original minimum -$1500 - each month, you could be out of debt in five years, though you'd still have to shell out $83,220 to do it. Needless to say, the more above the minimum you can manage to pay each month, the faster your debt will shrink.
Unfortunately, most folks who accumulate large amounts of credit card debt do so because they don't have much money to spare. If you're living paycheck to paycheck, setting aside enough of your income to pay more than the minimum each month may not be possible.
That's why bankruptcy can be such a relief for families stuck in the cycle of credit card debt. If you have lots of debt and little savings, filing for bankruptcy may be your best shot at financial freedom.
For those with limited income, Chapter 7 bankruptcy may be able to discharge unsecured debt in just a few months. If you own a home, Chapter 13 bankruptcy can set up debt payments on a manageable schedule while also protecting your assets and stopping foreclosure.
But the benefits of bankruptcy don't end when your debt is gone.
Without those annoying minimum payments each month, many families can finally start rebuilding credit and building up savings. From medical bills to job loss, unexpected circumstances will always have the ability to impact your finances. But an emergency fund can keep you from falling into the debt trap again, no matter what your future holds.
With the right bankruptcy plan, you can eliminate debt today - and tomorrow.