Credit Cards: The cost of paying the minimum

By | September 20, 2018

Making purchases with a credit card is often done out of one of two places: temptation or desperation. People who find themselves purchasing something with a credit card while being unable to pay for it at the time are usually either convinced it’s something they really need to have that moment, whether or not they can currently pay for it, or are simply just trying to survive through a difficult financial season.

Making purchases using a credit card is not automatically a terrible idea. In fact, it’s sometimes necessary to make ends meet. Using a credit card responsibly can help you build your credit score. Additionally, many credit cards offer valuable rewards such as sign up bonuses, cashback, frequent flyer miles, or other rewards points. Using a credit card can actually be financially beneficial to you when done carefully.

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When you receive your monthly statement, your credit card company offers a minimum payment amount that is usually significantly less than your card’s total balance. Your monthly minimum payment may be either a fixed dollar amount if your balance is pretty low, or it might be a certain small percentage of your balance if that comes out to be higher than the fixed dollar amount would be. Of course, if your balance is lower than the fixed rate when your payment cycle ends, the minimum payment would be the balance amount. Minimum payment amounts vary between credit card issuers, so be sure to look into how your credit card company determines your monthly minimum payment. Regardless, the minimum payment is almost always a drop in the bucket of your total credit card balance.

While it can be tempting to just pay that small, monthly minimum amount, especially if things are tight financially, making only the minimum payment month after month is not a great idea when it comes to doing what’s best for your future self for several reasons discussed below.  

Making only the minimum payment is significantly more expensive long term.

According to creditcards.com, the average interest rate on credit cards is currently over 16%. Making just the minimum payment on your credit card will draw out how long you will be allowing credit card debt to accrue interest, meaning you’ll pay significantly more in the long run.

Often, minimum payments are calculated to be just barely higher than the fees and interest charged that month. A majority of the minimum payment goes straight to your creditor’s pocket, barely touching your overall credit card balance. It may feel like you’re saving money in your monthly budget by just making the minimum payment, but it will cost you significantly more by the time it’s all said and done.

Your creditors are hoping you’ll find that small minimum payment amount enticing and only pay that amount month after month. The more people who pay back just the minimum amount each month, the more money they will earn in interest. If at all possible, make more than the minimum payment every month to keep money in your wallet and out of your creditor’s.

Bankrate’s website has a great Credit Card Minimum Payment Calculator that helps you see exactly how much making just the minimum payment will end up costing you. Plug in your credit card balance, interest rate, and the percentage of the balance your creditor uses to determine your minimum payment. The calculator will show you how long it will take you to pay that balance off by just making that minimum payment, and how much more it will end up costing you in interest. Your credit card statement should also have a section that shows you exactly how long it would take you to pay off your balance by making just the minimum payment.

Making only the minimum payment can hurt your credit score.

There are five primary elements that make up your credit score. One of those elements is credit utilization, which is the ratio between your current credit card balance and the available credit limit. Making only the minimum payment every month means your credit utilization will stay higher for longer. This can have a negative effect on your credit score as this factor weighs somewhat heavily in determining your score.

It’s better for your credit score, however, to make just the minimum payment than to skip it entirely. A late or skipped payment will also ding your credit score, so while it’s better to pay more than the minimum, be sure to make at least that payment every month to avoid seeing a negative effect on your credit score.

Making only the minimum payment will extend the length of time you’re in debt.

When you make a purchase on credit, you are borrowing from your future self to pay for it. By only making your monthly minimum payment, you are extending how much longer it will be until your future self is paid back. Before using a credit card to make purchases you know you won’t be able to pay back soon, actively think about whether or not the purchase is worth depriving your future self of that amount (plus interest).

Making only the minimum payment ties up your available credit for longer.

Credit cards are a lifesaver for many people when an emergency comes up. If your credit cards are maxed out because you’ve just been making the bare minimum payment monthly, you won’t have that to fall back on if an emergency comes up. The sooner your balance is paid down, the more credit you have available to you when you have to buy a new car battery or deal with a flat tire.  

What if I just can’t swing more than the minimum payment?

We’ve all been in situations where there’s more month than money. The minimum payment is just that: the minimum amount you can pay to appease your creditors for the month by holding up your end of the credit agreement.

If you have a particularly rough month or two financially, there’s nothing wrong with occasionally making just the minimum payment. It becomes more of a potential problem (and much more expensive) for you long term when you’re only making the minimum payment month after month.

What if I don’t even pay the minimum payment?

Failure to pay even the minimum monthly payment will lead to even more expense. Late fees can be added to your payment, and late or missed payments can negatively affect your credit score.

Even if you can only make the minimum payment, it’s always better to do so than to just skip the payment entirely and “make it up” next month. This will save you some money in fees, and prevent a ding on your credit score.

What if I have debt on multiple credit cards?

Having debt to pay off on multiple credit cards is a situation where making an exception might be warranted. If you have multiple credit cards to pay off, list them out along with the interest rates. Make an effort to pay off cards with higher interest rates first, which might mean making just the minimum monthly payment for a while on other cards with lower interest rates.

Throwing more money at getting those credit cards that charge a higher interest rate paid off first can actually be a good reason to only make the minimum payment on your card(s) with the lowest interest rate.

So, how much should I pay every month?

There’s no textbook answer to this question, as it varies depending on several different factors. Some people pay their entire card balance off every month. Others have a fixed dollar amount worked into their budget that they apply to their balance month after month.

Ideally, paying the entire balance off every month is best as you don’t have to pay any interest. However, that’s often not possible as credit cards are most often used to pay for things there aren’t funds immediately available in the checking account for. The amount you should put towards your credit card balance each month is going to be different for every cardholder, and might even vary month by month as your expenses and spending fluctuate.

To determine what you should pay towards your credit card balance for a certain month, take a look at your budget and determine how much you can comfortably put towards your credit card balance. Don’t overextend yourself financially and end up having to put all your basic living expenses for the next month right back on the credit card because you paid more towards the balance than you should have.

Anything above that minimum monthly payment is going to help you decrease your balance, so the more you can comfortably pay off each month without putting yourself in a position to end up adding right back to the balance, the better.

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