You might choose to make the minimum credit card payments each month, but is it hurting you in the long run? The minimum payment on your card is the lowest amount you can pay to the creditor for each billing cycle. If you can’t pay at least that amount by the due date each month, contact your issuer now.
By making the minimum payments, you’ll avoid late fees and penalties. It’ll also prevent credit bureaus from receiving missing-payment reports and tanking your credit score. But if you only cover the minimum payment, it won’t help you pay off your credit card balance very quickly.
The interest you’ll have to pay on the amount of your remaining statement balance can add up to almost as much as your minimum payment sometimes. With rising interest rates, it’s a good idea to try to lower your balance and reduce your debt sooner rather than later.
It’s important for credit card users to understand how minimum payments work so they can make the best decisions to pay down their debt.
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How are credit card minimum payments determined?
The minimum payment is the lowest amount you can pay in any given month to avoid penalties and fees. Credit card companies generally use four different methods for calculating minimum payments, which will depend on the balance and interest rate of the credit card. Here are the ways in which yours might be calculated.
Percentage of your balance: If you owe a significant amount of money on your credit card, your minimum payment will likely be around 2% to 3% of your balance, Debt.com resident expert and certified public accountant Howard Dvorkin told CNET. However, it could also be as low as 1%.
“Credit card companies make more money when the minimum payment is lower so more money goes towards the interest rate and less towards the principal,” Dvorkin explained.
Percentage of balance plus interest and fees: Some credit card companies will calculate your minimum payment by combining a lower percentage of your balance — often 1% — plus interest and fees from the past billing cycle.
Flat rate: If the unpaid balance on your credit card is relatively low, your minimum payment may be a fixed amount. There’s no standard among credit card companies, but from a survey of eight major credit card issuers, we found that flat rates ranged from $20 to $41.
Full payment: If your balance is lower than what the credit card company would charge as a flat rate, for instance $15, your minimum payment will probably be the full balance for that month.
Your minimum payment and how your credit card company calculates it should be included in your credit card agreement.
Experts recommend paying more than the minimum payment.
Let’s break it down. If you owe $10,000 on your credit card with an interest rate of 18% and make minimum monthly payments of $200 (using 2% of the balance), it will take you more than 50 years to pay off your debt. In that time, you will have paid a hefty extra $28,397 in interest. That’s nearly triple the amount you originally owed.
Since your minimum payment is based on a percentage of your balance here, as your balance decreases, so will your minimum payment. Making a fixed payment of $200 until your $10,000 balance is paid off would take less than eight years and cost you $8,622 in interest. That’s almost $20,000 in savings.
If you can’t pay your statement balance in full each month, Capital One suggests paying as much of the balance as possible. Paying even double the minimum amount can help significantly.
Using the previous example of a $10,000 balance and 18% APR, if you paid double your 2% minimum, or 4% of your balance each month, it would take 13 and a half years to pay off your debt, but you’d pay only $5,874 in interest.
“The higher your outstanding balance, the more interest you’ll pay, which can make it even more difficult to climb out of debt,” said Colleen McCreary, consumer financial advocate at Credit Karma.
Looking for a new credit card? Here are the best cash-back credit cards and the best credit cards for everyday use.
