The phrase, “Color of Money” is most commonly synonymous with the 1986 movie starring Paul Newman and Tom Cruise, but is considered to be a phrase used way back when to see what type of money someone actually had – that they were good for whatever the need was.
Money comes in many forms. What I will try to discuss in this blog is a few different types that take the form of financing, either for a consumer’s purchase or a patient’s service.
The color of money for lending credit can take the form of revolving line of credit or installment (closed-end) loan. A revolving line of credit, similar to a credit card, gives you money to use up to a maximum amount. As you make monthly payments on the account, your outstanding balance is reduced and funds available for use again expand commensurate with the amount of principal paid. All lenders of revolving lines of credit require a minimum payment amount, usually determined as a percentage of the outstanding balance.
An installment, or closed-end loan, also known as a personal loan, is a sum of money provided for a fixed amount of time and paid off in equal monthly payments, with interest, until the principal has been paid back. These loans are usually taken out for a specific purchase or use, such as a home improvement. Personal loans have a finite life span, unlike a credit line, which for many people can be a perpetual interest-bearing ball-and-chain!
Let’s look an example of this ball-and-chain. Since you only need to make minimum payments each month on the outstanding balance of the credit line, let’s say the minimum monthly payment is 3% and you have an outstanding balance of $4,000. Your payment in month one would be $120. For month two, your outstanding balance is $3,944 (principal paid down $120 to $3,880 plus monthly interest charge). As long as you don’t use any of the available credit, your minimum payment for month two would be $118. Since you are paying down the outstanding balance each month, the minimum payment will continue to be smaller. Sounds good, right? Wrong! Since you are paying a minimum of the outstanding balance, it will take an extremely long time to pay off the debt, and interest continues to be tacked on.
On a $4,000 outstanding balance at an APR of 19.99% paying the minimum monthly amount of 3% will take you 166 months to finally pay it off and you will have incurred $4,346.67 of interest charges, more than the amount you took out in the first place!
Calculate for yourself at https://www.creditcards.com/calculators/minimum-payment/.
To maintain financial discipline and keep a lid on interest you will pay on debt, stick with a personal loan as a form of credit.
~ David Weyher