Personal Finance Tip of the Week, By Financial Fundamentals, LLC of Watertown

This is the time of year when we begin to think about our New Year’s resolutions. If you are carrying a credit card balance, consider resolving to become a saver in 2015 instead of a borrower.

Credit card debt has the power to make you a borrower for a long time because of the high interest rates on cards. If you carry a balance, your monthly payment is split between interest due and the principal amount of your debt (the amount you initially borrowed). The interest portion tends to be big, especially if you carry a high balance, because of the high interest rates. This prolongs the amount of time you stay in debt. The reason: your monthly payment only reduces your principal balance by a small amount, and the amount that remains generates more interest charges that will need to be repaid.

This is a bad situation, because you are dedicating your financial resources toward paying interest on old debts instead of saving for your future goals. You are constantly looking backward instead of getting ahead.

Unfortunately, this lost opportunity to save for the future can be very large – several times greater than the principal value of your old debts.

To illustrate this point, let’s consider two people: Barbara, a borrower, and Sandra, a saver. Barbara decides to splurge on a vacation and puts $5,000 on her credit card. When she returns from her trip, she begins to repay her balance by making a monthly payment of $80. Her card charges a 15% interest rate, which prolongs the time required to repay the debt. In fact, it takes Barbara 10 years to completely pay off the credit card.

Sandra is the exact opposite of Barbara. Sandra deposits $5,000 into a Roth IRA account to save for her retirement. Then she makes a monthly deposit of $80 into the account. She continues to make these monthly deposits for 10 years, the same amount of time that it took Barbara to pay off her loan. But Sandra earns a 7.5% rate of return on her savings, just one-half of the interest rate that Barbara pays.

Can you guess Sandra’s balance after 10 years? It’s almost $25,000! That’s 5 times the amount that Barbara initially borrowed. While Barbara repaid her old debt, Sandra got five times further ahead toward her dreams.

And what if Sandra never made the initial $5,000 deposit, and only made a monthly deposit of $80 for 10 years? At that point, her balance would be almost $15,000 – 3 times the amount that Barbara borrowed! So you don’t need to make a big initial deposit to get ahead. You just need to stick to a pattern of regular savings.

This hypothetical example illustrates the unfortunate power of credit card debt. High interest rates rob you of the opportunity to save for the future, and the financial impact can be several multiples greater than your initial debt.

But it also illustrates the positive power of being a saver instead of a borrower, and of committing to a regular savings routine. For 2015, make a resolution to retire your credit card debt for good, and to capture the benefits of being a saver instead of a borrower!

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Stephen Barkhuff, CFP(R), CFA is the founder and president of Financial Fundamentals, LLC, based in Watertown, MA. Financial Fundamentals helps couples and singles with modest incomes take control of their financial future. Please feel free to email him any questions or comments.