Itâ€™s always tempting to just pay the â€śminimum paymentâ€ť on your monthly credit card statement. The minimum payment dollar amount is far more appealing than the actual balance, and itâ€™s better than nothing, right? If youâ€™re in a tough bind this month and short on cash, itâ€™s important to understand what happens if you only pay the minimum every month on your credit card.
Like your student loans, mortgage, or any other loans, a â€śminimum paymentâ€ť is the lowest possible payment your lender allows you to make on a monthly basis. Each credit card company calculates the minimum payment amounts differently. Some credit cards calculate it as a percentage of your total balance (usually 2% to 4%) and others calculate it as the interest that is on the card that month plus 1% of the balance.
Regardless of how your credit card company calculates your minimum payment, the minimum payment offers a false sense of security to consumers who want to get out of debt sooner. Refinancing credit cards at a lower rate with a personal loan is one reliable method of doing that (ReadyForZero has a tool to check your rate), but if youâ€™re continue paying off your credit card with only monthly minimum payments, hereâ€™s what happens:
Youâ€™re Paying Off Mostly Interest Not Balance
If youâ€™re only paying the minimum payment, keep in mind that most of that money is paying for the interest you are accruing on the principal balance and NOT the actual principal balance, or the actual amount borrowed from the credit card company.
Letâ€™s say that you have $1,000 on your card, and the credit card calculates your minimum as 2.5% of your total balance, then your minimum payment is $25 every month. If your annual interest rate, or APR, is set at 18%, you owe $180/year on your $1000 balance in interest charges. You end up paying $300/year in minimum payments ($25/month times 12 months). So thatâ€™s only $120 that youâ€™re actually paying off on the principal balance ($300 in minimum payments minus $180 you owe in interest). So your balance is still $880 after a year of youÂ making monthly minimum payments.
Even if your credit card calculates minimum payments differently and you might even have a lower interest rate than 18%, your minimum payment mostly goes towards interest and not your principal balance.
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Credit Card Interest Keeps Growing
Credit card companies do not calculate the minimum payment amount to help you pay off your balance faster. Theyâ€™re a business, and like any business, they want to maximize their profits. They do this through interest charges, and hope that you will pay just the minimum payment because it maximizes their profits. The longer it takes you to pay off your credit card, the more total interest you pay on your principal balance. By only paying the minimum payment, youâ€™re only slowly paying off the principal balance that continues to sit there accruing more interest every month.
Using the above example and the ReadyforZero credit card debt calculator, letâ€™s see how much MORE interest youâ€™re paying if you only pay the minimum payment of $25 month versus if you chose to pay $50/month.
If you pay the minimum, then it will take you 5 years and 3 months to pay off the credit card, and you end up paying a total of $1,566, or $566 in interest charges.
If you to pay $50/month, then it will take you 2 years and one month to pay off the credit card, and you end up paying a total of $1,205, or $205 in interest charges.
While $25 more a month might feel like a stretch for your budget, think of the small ways you can save to put that extra $25 a month toward your credit card bill. By paying just $25 a month more on your credit card, you save yourself over $350 in interest charges and pay off your card twice as fast.
It Can Negatively Affect Your Credit Score
If you pay the monthly minimum payment, you are still paying your credit card on time and this counts as positive payment history, which is good for your credit score. Additionally, you are not penalized for the extra interest youâ€™re paying when you only make monthly minimum payments.
But when you only pay the minimum, you are not actually lowering your credit card debt balance by that much. This balance amount is relevant for your credit score, because one factor included in determining your credit score is your credit utilization ratio. This measures how much you use of your available credit. Carrying a balance of over 30% of your credit limit can harm your credit score.
For example, if you have a $2,000 credit limit on your credit card, and youâ€™ve charged over $600 on the card, you begin negatively affect your credit score. The closer you get to $2,000 on that credit card, the more your credit score suffers. If youâ€™re only making minimum payments, youâ€™re over the 30% threshold for a longer period of time and the longer youâ€™ll be negatively affecting your credit score.
Bottom Line: Donâ€™t Get Stuck Always Paying the Minimum on Your Credit Card
Donâ€™t be deceived by the minimum payment amount printed on your monthly bill, because itâ€™s been calculated to help the credit card company. Minimum payments will not help you achieve your goals of gaining financial freedom and getting out of debt faster.
Donâ€™t forget the earlier example! If you only paid the monthly minimum on a $1000 credit card balance, itâ€™d take you over twice as long and cost you more than twice as much than if you doled out just $25 a month more for your credit card payment.
Paying the minimum payment is not a good idea, and as a long-term strategy, it can be an absolute nightmare. If youâ€™ve found yourself struggling every single month to pay more than just the minimum and are concerned about your credit and long-term financial health, you might also want to consider debt consolidation as an option to help you get rid of your credit card debt faster.
Before youâ€™re tempted to only pay the minimum this month, try signing up for ReadyForZero to monitor your accounts and payments, and use the credit card debt calculator to see how much your payment this month will affect your long-term financial goals. You can also see ReadyForZeroâ€™s recommended best credit cards.
For additional resources, you can also check out our ReadyForZero credit card debt resource center.
This post was published by Felicity Nie, ReadyForZero Writer for Â»Â ReadyForZero.
ReadyForZero is a company that helps people get out of debt on their own with a simple and free online tool that can automate and track your debt paydown.Download