There are surefire ways to get credit card debt under control but the minimum payment is not one of them. While it will keep your account from being considered delinquent, it will not help improve your credit situation. In fact, it may even make things worse.
According to CreditCards.com, the credit card minimum payment is the lowest amount that is required from you every billing. This is computed based on the specifications found in the terms and conditions of your credit card. Before 2004, the minimum payment requirement is calculated based only on 2% of your balance. But the current industry standard is now 3%-5% – depending on the credit card company.
When your billing statement comes, it will show you how much you owe in total and it will also indicate the minimum amount that you are required to pay for that particular month. Since this amount is based on the previous balance of your card, it changes every statement.
Failing to pay this amount will trigger a late penalty fee. This is why you need to take notice of the minimum payment. But if you stick to this amount alone- that can also prove to be equally dangerous.
How paying the minimum of your card balance is destructive
There are three main reasons why we think that paying only the minimum on your credit card statement is bad. In fact, we dare to say that it can slowly kill your personal finances. If you have dreams of pursuing wealth, then you need to go beyond the minimum required amount in your payment.
Let us show you the difference between a credit card balance that is paid using the minimum payment and one that is given more. Using the Bankrate.com minimum payment calculator, here are the computations that we got.
Assuming a debt of $10,000 with a 15% APR and 4% minimum payment computation.
- Paying only the minimum amount (starting with $400 and going down as the previous balance decreases). You can completely pay off your debt in 148 months or more than 12 years. In that time, you will also pay $4,452.37 in interest.
- Paying $400 consistently every month. You can completely pay off your debt in 31 months or more than 2 ½ years. In that time, you will pay $2,065.31 in interest.
- Paying an additional $10 = $410 every month. You can completely pay off your debt in 30 months or 2 ½ years. In that time, you will pay $2,003.22 in interest.
- Paying an additional $50 = $450 every month. You can completely pay off your debt in 27 months or 2 years and 1 quarter. In that time, you will only pay $1,788.72 in interest.
- Paying an additional $100 = $500 every month. You can completely pay off your debt in 2 years. In that time, you will only pay $1,579.47 in interest.
All of these are with the assumption that you will not use your card until it has reached zero balance. As you can see, if you stick to the computed minimum amount, that will eventually lead to your destruction. But if you do not change the initial minimum payment, in this case $400, you can completely pay off your debt a lot faster.
3 ways the minimum can compromise your personal wealth
Looking at the data provided above, we can conclude that sticking to the minimum payment will result in three negative effects.
It keeps you in debt for a long time.
First of all, sticking to the minimum amount will keep you in debt for a lot longer than you should. As shown in the example above, the minimum payment method will keep you in debt for 12 years and more. But if you keep to the $400 initial minimum requirement and continuously pay off that amount, you can completely get rid of your balance in less than 3 years. Even if the minimum amount gets lower, you need to discipline yourself and continue to allocate a constant amount.
It increases the interest that you pay.
As with any type of debt, if you choose the longer method of payment, you will naturally end up paying a bigger interest amount. As with the example above, the minimum payment will get you to pay $4,452 worth of interest. If you keep to the initial $400 minimum payment, regardless if the lower balance results in a lower minimum requirement, you will only pay $2,065 on interest. That is more than 50% less.
It does not promote proper payment behavior.
The use of credit cards will really teach you a couple of bad spending habits. By sticking to the minimum requirement, you will also develop bad payment behaviors. Not only that, the minimum payment every month does not put a huge dent on our budget. That contributes to our credit card dependency. Since the monthly payment does not seem too high, we end up choosing this mode of payment without giving thought to the amount that we are actually paying every month.
Effects of the minimal credit card payment on your credit score
Another impact of making the minimum payment can also be reflected on your credit score. While it is not a direct impact, it does have some lingering effects that you may want to know of.
Bad credit scores negatively impact our lives and you do not want that on top of your growing debt amount. That being said, you may want to pay attention as to how putting in more payments every month can benefit you.
According to a blog article published on Credit.com, maintaining the minimum payment will keep your payment history in good condition. There is no question about it. But while it will not be bad for this portion of your credit report, there are other factors that you need to consider as well. The article cited certain problems that can crop up as you stick to the minimum requirement of your credit card statement.
- The minimum contributions every month will drive your balance up – endangering your credit limit/balance ratio. This is 30% of your credit score.
- Viewers of your credit report will also question why you only pay the minimum amount of your credit card balance. This can indicate a behavior of yours that borrows more than what they can afford to pay off. It is not a good indication of your payment habits.
- Analysts say that paying only the minimum amount on a credit card balance are more likely to default than those who paid their balance in full each month.
The effect of paying only the minimum requirement may indirect but that does not mean it will not affect your finances. Remember that a high credit score itself will not guarantee that you will be granted a low interest on your loan. The lender will look at other factors and that most important will be your payment behavior. A minimum payment habit does not really give much confidence about the chances of your defaulting on a new debt.
That being said, you may want to put in more money towards your credit card payments. It does not have to be too big. Set a specific amount that you will pay towards your debts and stick to that regardless if you are allowed to pay lower. That is how you discipline yourself to get out of your credit card debt.