When it comes to credit cards, making the minimum payment is better than nothing — but don't pat yourself on the back if you're doing so on the regular. Whether you realize it or not, you're in a tangled financial web because so little of your payment is being applied to the actual credit card debt.
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That's tough to hear for many folks. A study from the National Bureau of Economic Research found that 29% of credit card account holders make payments at or near the minimum. And according to research reported on CreditCards.com, 37% of U.S. households carry a credit card balance from month to month, and the average balance at the end of 2018 was $6,506.
Read on to learn why making a credit card minimum payment is a bad idea.
4 Reasons NOT to Make a Minimum Card Payment
The Math Isn't on Your Side
Think about what happens if you have $3,00 worth of credit card debt with an 18% interest rate. A standard minimum payment of 3% would be $90 per month. Paying only the minimum (which will decrease over time) would cost you $2,698.44 in interest and take nearly 16 years to pay off, says Freddie Huynh, vice president of credit risk analytics with Freedom Financial Network. "That means you will be paying almost twice as much for what you bought in the first place," he says.
Make use of online calculators that let you enter different variables and find out how much paying only the minimum will cost you. Also check the "Minimum Payment Warning" on your credit card bill. It should include a table that shows how much money and how many years you'll need to pay off your balance if you pay only the minimum each month.
Most credit card companies calculate your minimum monthly payment as a percentage of your current balance, and they often require a minimum payment of about 3% of the balance. "If the balance goes up during the month, your minimum payment goes up. If your balance goes down, your minimum payment goes down," explains Todd Christensen, education manager for Money Fit, a nonprofit debt relief agency.
Also remember your rights under the CARD Act. If you make your minimum payments on time or even within 60 days of the due date, your credit card company can't increase your standard interest rate, increase fees, or add finance charges, unless you've been in a temporary or promotional program or are on a limited debt repayment hardship program with your creditor.
It's a Lost Opportunity
Make just the minimum payment, and you lose the chance to do something good with the money you're paying to the credit card issuer in interest. "If your credit card charges 20% interest, and you pay off the balance, you are guaranteed to save yourself from losing 20% — which is, in effect, making a 20% return," Huynh explains.
You're Just Treading Water
Talk about a vicious cycle. Making only the minimum payment is a little like the old adage of "take one step forward, two steps back." Interest continues to accumulate, and the minimum payment often will only be about the same as the amount of the previous month's interest. Plus, if you're still charging purchases on the credit card, you'll fall even further behind.
Your Credit Score Could Suffer
Your FICO credit score may fall because your utilization percentage will rise. To illustrate, if the sum of your credit card limits is $10,000, and the total credit card balances you have equal $3,500, that's 35% utilization; it's the percentage of your available credit that you are using.
Credit card utilization can greatly influence your credit score — in fact, it's 30% of your FICO score and the second-most important factor behind payment history, points out Rebecca Hunter, CEO of The Loaded Pig, a personal finance website. It's important to keep your credit card balances and utilization low; high credit card balances can negatively impact your score.
When Does a Credit Card Minimum Payment Make Sense?
If you're trying to eliminate debt, it might be alright to pay just the minimum payment on your credit cards so you can apply more money to other debts, explains Deacon Hayes, founder of WellKeptWallet.com.
For example, when using the snowball debt repayment method, you'll pay the minimum on all debts each month except the one with the smallest balance. Once the smallest debt is paid, you'll add that monthly payment amount to what you pay on the next-smallest debt to help you pay it off at a faster rate. By continuing this process each month and not adding to your debt, you can eventually become debt-free.
But mostly, paying only the minimum is a no-go. "I can't think of a reason to ever make only the minimum payments on a credit card," Christensen says. "If you can only afford minimum payments, that should be a major sign your finances are in danger of a massive downward tailspin."
Readers, what are your best tips for paying off credit card debt? Let us know in the comments below!