MAT 245 Module 4 Consumer Credit and Debt Example

Fourteen Years or Eight Months: Paying Off a Credit Card and Managing Debt as a Young Professional

Student Name

Business Administration Program, Aspen University

MAT 245: Personal Finance

Instructor Name

Month Day, Year

Fourteen Years or Eight Months: Paying Off a Credit Card and Managing Debt as a Young Professional

Taylor Monroe has three debts. The credit card balance has hovered around $3,800 for two years because Taylor pays a little more than the minimum and keeps using the card. The car loan and student loans are paid on schedule. In Module 2, Taylor's budget set aside $560 a month for the card. This paper shows what that payment accomplishes compared with paying the minimum, sets an order for the debts and explains why so many people underestimate what debt costs. It is a model for learning, not advice for a particular reader.

The Debts

Two Paths for the Card

At 24% a year, the card charges 2% a month. If Taylor stopped using the card and paid only the minimum, 3% of the balance, the balance would shrink by about 1% a month, so the required payment would also shrink. It would take nearly ten years to reach the $35 floor and about four and a half more years after that to finish, roughly 173 months in all. Taylor would pay about $9,800 in total, around $6,000 of it interest.

At a fixed $560 a month, the balance is gone after about seven and a half months, eight payments, with about $320 in interest. The difference is not the interest rate, which is the same on both paths, but how long the balance is allowed to stay outstanding.

Why People Misjudge Debt

Stango and Zinman (2009) studied exponential growth bias, the tendency to perceive compound growth as if it were linear. In survey data, people with more bias underestimated the interest rate implied by a loan's payments and the future value of savings. People who misjudged compounding most took on more debt, put away less and carried more of their borrowing as costly short-term credit. The bias helps explain why minimum payments seem harmless: the balance falls a little each month, and the cost of the long tail of interest is hard to see. Taylor, asked before running the numbers, guessed that minimum payments would clear the card in about three years, a typical underestimate.

Regulation and Card Costs

Agarwal et al. (2015) studied the Credit Card Accountability Responsibility and Disclosure Act of 2009, which limited fees such as over-limit and late fees and required statements to show how long minimum payments would take. Using data on credit card accounts, they found that the limits reduced total borrowing costs substantially, especially for borrowers with lower credit scores, without offsetting increases in interest charges or reductions in credit. The minimum payment disclosure on Taylor's statement, which shows the long payoff time, is one result of the law.

Self-Control and Knowledge

Gathergood (2012) studied overindebtedness among consumers in the United Kingdom. Both self-control problems, such as impulsive spending, and low financial literacy were associated with overindebtedness, and self-control problems had a stronger association. Consumers with self-control problems were more likely to use high-cost credit and to suffer debt shocks.

Taylor's card balance stayed flat because new spending replaced every payment. Two years of payments had gone almost entirely to interest and new purchases, which is why the balance looked stuck despite Taylor paying more than the minimum each month. The plan therefore removes the card from Taylor's wallet until the balance is paid.

The Repayment Order

The card goes first because its rate is highest; paying it off is equivalent to a risk-free return of 24%. The car loan and student loans stay on their regular schedules. Once the card is paid, its $560 moves to the emergency fund, as planned in Module 2. Paying the smallest balance first, the snowball approach, would choose the same debt here, because the card is both the smallest and the costliest.

The Car Loan and Student Loans

The car loan, at 6.9%, ends in about two years at its current payment. Paying it faster would save some interest, but the emergency fund comes first, because a car loan paid off early does not help if Taylor has no cash when the transmission fails. The student loans, at 5.5%, are federal loans with protections that private loans lack, such as income-driven repayment and deferment in hardship, so Taylor will not refinance them into a private loan for a slightly lower rate. Once the card is gone and the emergency fund is built, the car loan's $240 will move to the down payment fund when the loan ends.

Avoiding New Debt

A plan to pay off one card fails if new debt replaces it. Taylor will decline store credit offers, will not open a buy-now-pay-later account for purchases that fit no budget category and will treat the irregular expenses fund from Module 2 as the first source for unexpected costs.

Protecting the Credit Score

Credit scores weigh payment history most and also consider how much of available credit is used, the length of credit history and recent applications for new credit. A strong score will matter when Taylor applies for a mortgage in Module 5's timeline, because it affects the interest rate offered. Paying the card to zero lowers utilization sharply. Taylor will keep the card open, with one small subscription charged to it and paid in full automatically each month, and will check all three credit reports once a year at the official free site.

Conclusion

Paying $560 a month instead of the minimum saves Taylor about fourteen years and more than $5,000. Stango and Zinman, Agarwal and colleagues and Gathergood explain why the minimum feels harmless, how regulation changed card costs and why self-control matters as much as knowledge.

References

Agarwal, S., Chomsisengphet, S., Mahoney, N., & Stroebel, J. (2015). Regulating consumer financial products: Evidence from credit cards. The Quarterly Journal of Economics, 130(1), 111-164. https://doi.org/10.1093/qje/qju037

Gathergood, J. (2012). Self-control, financial literacy and consumer over-indebtedness. Journal of Economic Psychology, 33(3), 590-602. https://doi.org/10.1016/j.joep.2011.11.006

Stango, V., & Zinman, J. (2009). Exponential growth bias and household finance. The Journal of Finance, 64(6), 2807-2849. https://doi.org/10.1111/j.1540-6261.2009.01518.x