Feel good about making those minimum credit card payments every month on time? You shouldn’t. Credit card companies design minimum payment schedules to give them the greatest possible amount of interest over the longest period of time.
Learn how to overcome the obstacles of minimum credit card payments with the advice below.
Calculating How Much It Will Cost to Pay Off Credit Cards
The Federal Reserve System offers a free and simple credit card payment calculator that lets you calculate how long it will take to pay off your credit cards with the minimum payment, assuming you do not make any more charges. The results are shocking.
The calculator assumes that the credit card company calculates a minimum at 2% of the current balance. Using that assumption, let’s take a look at a credit card with just a $1,000 balance at 24% interest. What is your best guess as to how long it will take to pay it off? A year? Two years? The correct answer is: Never. Yes, never, because the 2% monthly payment ($20.00) would be less than the interest ($24.00). For a card with a $500 balance, it would take three years of minimum payments, after which you would have paid $201 in interest in addition to the principal.
The system works in favor of the credit card companies which is why so many people stay in debt. The Credit CARD Act of 2009 created several consumer-friendly provisions, including a requirement that credit card issuers tell consumers the consequences of making minimum payments only—including details on how long it would take to pay off the entire balance with minimum payments.
Industry Changes in Paying Off Credit Cards
In response to recent changes in credit law, some lenders have raised the minimum. While 2% remains the standard, some have raised it to 4% or more. JPMorgan Chase, for example, raised their minimum to 5% recently. This action does give you a bigger minimum payment every month, but it does have a positive impact on consumers.
While many consumers have decried the action, it is a step in the right direction for a credit industry that has in the past forced consumers into endless cycles of debt. When a credit card company raises its minimum monthly payment, they are not actually receiving any more money—in fact, they will receive less overall in interest. They will just get the balance faster because you’ll be paying it off in less time. It is best for both parties, and by forcing debtors to make larger monthly payments, the specter of endless payments decreases.
When Should You Pay the Credit Card Minimum?
The best way to pay off credit cards is by making larger payments. When that is not possible, the minimum does serve as a fallback position. Generally speaking though, making the minimum payment should only be done in emergency situations.
For example, if you have an emergency car repair bill to pay, making the minimum credit card payments for just one month is an acceptable short term solution. Making the minimum payment is also acceptable if your balance is very low. Most credit card issuers figure the minimum based on either the 2% figure or an alternative minimum, such as $20. If for example, your balance is $100, you would not pay just 2%–you would pay $20, which is a full fifth of the balance and would be a reasonable strategy.
Creating a Credit Card Payment Schedule That Works
Use this as a general rule of thumb: if your current credit card payment schedule does not pay off your balance in under a year, you are not paying enough.
If you are looking to figure out how to pay off credit cards, making minimum payments is not going to get you anywhere except on a treadmill of debt. Credit cards in general are a good consumer tool, give you buying power, and allow you to build your credit, but they must be used strategically. Keep credit balances low to about 20-30% of available credit at all times, and make large payments whenever possible to keep your interest expenses down.
Remember, the minimum payment works more in favor of the credit card company, not the consumer. It should only be reserved for times when your budget is extremely tight or if you can’t afford to pay anything more than the minimum.