Imagine you’re on a sinking yacht in the middle of the Pacific Ocean. There’s enough space on the lifeboats for everyone, but for some reason not everyone is evacuating. One guy believes he’s strong enough to swim back to shore despite the freezing waters. A second person is too busy online trying to secure a helicopter rescue despite the weak WiFi signal. A third guy just isn’t quite convinced that the boat is REALLY sinking so he’s not going anywhere.
“Lucky Strike” Larry earns $5,000 a month, but has outstanding credit card debts of $75,000. That’s more than 12 times his monthly income. Most of the accumulated debt actually comes from interest. This is because Larry only pays the minimum amount demanded by the credit card companies each month.
Most credit cards in Singapore calculate their minimum payment by saying “3% or $50, whichever is larger”. That means for any outstanding amount above $1,666, you pay 3% of the outstanding amount. For any amount $1,666 and below, you pay a minimum of $50.
Let’s see what Larry’s options are:
Scenario 1: Larry only pays the minimum amount required each month
If Larry sticks to what he’s been doing, he will spend 379 months of paying the 3% minimum. This will bring his outstanding amount to $1,662.63, and he will spend another 56 months of paying the minimum amount of $50.
Total time taken to pay back: 379 + 56 = 435 months or 36 years and 3 months
Total interest paid: $146,675.67 (for the first 379 months) + $1,099.16 (for the next 56 months) = $147,774.83
36 years and 3 months. That’s more than enough time for Larry to have a kid, for the kid to go to university, get married and give Larry a grandchild. Except he can’t afford any of that, because he spent all that time paying off his credit card debt. What makes it worse? Because of interest, Larry’s debt ballooned to 3 times what he owed. He could have bought a new Toyota Corolla Altis with the interest he ended up paying. With COE!
But I hear you saying, no one’s that stupid – he won’t be paying the minimum amount forever. Fine, let’s look at the other extreme, where Larry dedicates himself to paying off the debt with fixed amounts.
Scenario 2: Larry pays $2250 every month till the debt is paid off
Let’s assuming Larry’s commitment and dedication is on the same level as Will Smith and Jada Pinkett Smith’s marriage. No matter how many bad Hollywood decisions they’ve made (After Earth and Gotham just to name two) they still remain true to one another after 18 years of marriage.
Larry doesn’t need 18 years. His minimum amount for the first month is $2,250 (3% of $75,000). Assuming he sticks to this amount till the debt is fully paid, let’s see how long he’ll take.
Total time taken to pay back: 56 months of paying $2,250 each month or 4 years and 8 months
Total interest paid: $49,831.30
4 years and 8 months sounds like a pretty good deal. But let’s look at what this is really going to cost him. Larry’s pay is $5,000 a month. Taking into account his CPF contributions, that means he only takes home $4,000 a month. If he sets aside $2,250 just to pay his credit card debt, that leaves him with only $1,750 for his monthly expenses. It’s more than enough to survive, sure, but I really won’t call it living. When you think about what kind of lifestyle Larry must have had to chalk up that kind of credit card debt, having to turn his life around and live month to month on a reduced income for almost 5 years is going to be tough.
But wait, Larry might get lucky during that 5 years. He might win Toto, or his business is acquired for a ridiculous sum of money, or even better still, a rich Nigerian prince has problems claiming his inheritance and Larry is the only person who can help him.
Scenario 3: Larry only pays the minimum amount required, but in 5 years, wins Toto
Larry’s not called “Lucky Strike” for nothing. He knows he’s going to get his big break within 5 years, so he doesn’t see the need to do anything more than pay the minimum amount. Say he really strikes Toto after 5 years:
Total time taken to pay back: 60 months of paying 3% minimum or 5 years
Total interest paid: $67,926.33
Toto winnings required to escape in 5 years: $41,035.50
After 5 years, Larry’s debt would only have been reduced by $33,964.50 or less than half his outstanding debt. Larry’s windfall has got to come up with the difference of $41,035.50.
Sure, people have won much more than that in Toto before. But hoping to win the lottery in order to repay your debts is like hoping to find your soulmate through Tinder. I’m not saying it’s not possible. I’m just saying that’s not what most people use it for.
Scenario 4: Larry looks to the RAS for help
Since Larry’s credit card debt is $75,000 and more than 12 times his monthly salary of $5,000. He is therefore eligible for the Repayment Assistance Scheme (RAS). What the RAS does is it separates the amount that exceeds 12 times of the monthly salary and offers to repay it at lower interest rate of 5% over 8 years. The remaining amount of 12 times of the monthly salary can be settled at your own discretion.
What does this mean for Larry?
12 times Larry’s monthly salary is $60,000. This is the amount he has to settle on his own. The remaining $15,000 will fall under the RAS.
RAS repayment amount: Larry only has to pay $189.90 a month for 8 years.
RAS interest: $3,230.28
As for the $60,000 he has to settle on his own, here are two possible options:
Option A: If he only repays the minimum amount
Total time taken to pay back: 357 + 56 = 413 months or 34 years and 5 months
Total interest paid: $116,670.48 (for the first 357 months) + $1,091.42 (for the next 56 months) = $117,761.90
Including RAS interest: $117,761.90 + $3,230.28 = $120,992.18
It’s clear that even with the RAS, Larry will still take over 30 years to repay his loan if he sticks to minimum amounts. The main thing the RAS does for him is reduce the total interest he pays by $26,782.65, or by about 18%. That’s still pretty decent, all things considered.
Option B: If he repays a fixed amount of $1800 each month
Total time taken to pay back: 56 months of paying $1,800 each month or 4 years and 8 months
Total interest paid: $39,865.04
Including RAS interest: $39,865.04 + $3,230.28 = $43,095.32
Of course, it must be noted that Larry has to repay a total of $1800 + $189.90 (for RAS) or $1989.90 a month. That’s still less than the monthly payment of $2250 in Scenario 2. Larry also pays $6,735.98 or 13.5% less interest compared to Scenario 2.
What does all this mean for Larry’s credit card debt?
These 4 case studies are over-simplified, for convenience. It assumes that Larry never spends further on his credit cards, for one thing. It also assumes the typical credit card interest rate of 24%. However, for banks like DBS, UOB and OCBC, credit card interest rates are going up so that means Larry may end up repaying for a longer period of time. Finally, we don’t take into account personal loans, which usually have lower interest rates.
Just looking at the four options presented, it’s clear that the best scenario happens when Larry is able to win Toto, the earlier the better. Failing which, something like the RAS, though it locks him in for 8 years, does help to make a difference in the total interest Larry end up paying compared to not taking up the RAS.
What do you think is Larry’s best option in this case? Do you know of other ways that Larry can get help with his credit card debt? Share them with us.
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Tags: Credit Cards