Credit card debt is about as much fun as a stubbed toe or getting in a parking lot fender-bender.
Credit card payments can put a strain on your financial resources. Just like a lingering toothache, your card balances won’t go away unless you take action by making substantial monthly or one-time payments. Sometimes, though, that’s not financially possible, and you can only afford to make minimum monthly payments on your credit cards.
Making only minimum payments on card balances extends the time it takes to reduce or eliminate credit card debt and costs you additional money in interest payments. Let’s take a closer look at the financial ramifications of only paying the minimum amount due on your credit cards.
What Is a Minimum Credit Card Payment?
When you carry a balance on a credit card, you aren’t required to pay the full amount each month. You can make a small payment that represents a minor portion of your balance to satisfy payment requirements. This small payment is called the minimum payment.
How Credit Card Companies Calculate Minimum Monthly Payment Amounts
Card issuers use a few different methods to calculate minimum monthly payments:
Flat fee. Card issuers may set a flat fee to satisfy monthly payment requirements. Flat fee payments may be set at $30-$40 or more, depending on the amount of your balance.
Percentage of total balance. This is the most common method of calculating monthly payments for credit cards, especially when balances are high. Payments can be calculated between 1% and 3% of your total balance, though percentages vary among card issuers. A card with a $1,000 balance at 3% would have a $30 payment.
Combination of percentage and interest. This calculation method combines a percentage of your outstanding balance with the interest being accrued on that balance. For example, a $1,000 balance with a 20% interest rate would have a minimum monthly payment of $26.67.
Minimum payments are calculated as a portion of your outstanding card balance.
The table below illustrates these various payment calculation methods, along with the amount of interest you pay by only making monthly minimum payments and the total time it would take to completely pay off the debt.
Comparing Credit Card Calculation Methods
If you miss a payment, your card issuer will add it to your next monthly payment along with any subsequent interest and late fees.
Long-Term Impact of Paying Minimum Amounts on Credit Cards
Remember that nagging toothache? Imagine waiting a year to see a dentist. What was once a simple $300 cavity has turned into a $6,500 implant.
Making minimum monthly payments on your credit cards is similar—you are extending your financial pain and costing yourself much more money through accrued interest.
How Credit Card Interest Works
Generally speaking, card issuers charge interest on any balance that’s remaining after your monthly statement closes. Interest accrues daily on the outstanding balance and is based on a daily periodic rate. To figure DPR, divide your credit card’s annual percentage rate (let’s stick with 20%) by the number of days in a calendar year.
20% ÷ 365 = .0547% DPR
Interest continually accrues and compounds, so each day, you are costing yourself more than the previous day by only making minimum monthly payments. Card issuers add up this daily amount each month and add it to your total balance in the form of a finance charge.
The longer you make only minimum monthly payments, the more you eventually spend on finance charges. A credit card calculator can help you see different credit card payoff scenarios.
3 Benefits of Paying More Than the Minimum on Your Credit Cards
Reducing and eliminating credit card debt as fast as possible is smart money management. Paying more than the minimum monthly payment offers multiple benefits.
- Reduced interest. The sooner you pay off your outstanding balance, the less you’ll pay in interest.
- Increased credit score. Credit utilization — the balances on your credit cards versus available limits — accounts for 30% of your FICO score. Reducing your credit utilization typically provides a beefy bump to your credit score.
- Reduced debt load. Eliminating debt wherever possible provides more than peace of mind. It frees up additional funds that can be used elsewhere or stashed as savings. The amount of your overall debt you carry also significantly impacts your credit score.
3 Strategies for Quickly Reducing Credit Card Debt
You can implement several proven strategies to quickly reduce credit card debt.
- Debt avalanche. With this strategy, you’ll target the card with the highest interest rate. Make minimum monthly payments on all other sources of debt and allocate as much money as you can each month to the card with the highest interest rate to shed that debt as fast as possible.
- Debt snowball. Here, you’ll first target the smallest card balances to be done with them. Once you zero out a card, roll those additional funds onto the next-largest balance, and so on.
- Balance transfer. Many credit card companies offer the ability to shift debt from one card to their card with a reduced or zero APR for a set period. You could use the money you are saving in interest to make larger payments on card balances. Balance transfers come with a fee, though — usually around 3% of the amount being transferred.
Debt Consolidation: Your Alternative to Minimum Card Payments
Making minimum monthly payments on credit cards will significantly extend the time it takes to be free of credit card debt and cost you a great deal of money in interest. A debt consolidation loan may be a good solution.
Why Consider a Debt Consolidation Loan
You may find it more advantageous to take out a personal loan and pay off all your credit cards at once. If you have exemplary credit (740 and up), you may be able to get favorable loan terms with an interest rate that’s half of what you are paying on your credit cards.
The benefits: You’ll have a clearly defined target date to be debt-free and save a ton in interest payments. You’ll have a set interest rate and monthly payment that won’t fluctuate.
The drawbacks: You’ll likely have higher monthly payments, especially if you have high card balances because you’ll have shorter loan repayment terms of three or five years. If you begin using your credit cards again, you’ll just be adding to your overall debt load and could find yourself in the same situation all over again with the added financial burden of the debt consolidation loan.
What You Can Save With a Debt Consolidation Loan
The table below illustrates a debt consolidation loan versus making payments on your credit cards.
With a debt consolidation loan, your $20,000 in credit card debt can be paid off in 36 to 60 months. With a five-year loan, that’s roughly the same amount of time, but you’ll pay just over $6,000 in interest versus a combined $12,430. The combined credit card payments are $560, versus the slightly lower five-year payment and nominally higher three-year payment shown for the debt consolidation loan.
When Minimum Payments Are Unavoidable: What to Watch Out For
Oftentimes, making minimum payments on credit cards stems from a lack of funds. The following warning signs are red flags that your mounting credit card debt could put you in serious financial jeopardy.
Your Cards Are at or Near Max Credit Limits
There’s no clearer signal that you are spending beyond your means than maxed-out credit cards. In addition to hurting your financial stability, you are hurting your credit score, which could impact your ability to get approved for a variety of loans or secure new lines of credit.
You Can’t Pay Down Balances
Rising debt or debt you can’t pay down should be a clear sign that your spending habits exceed your income.
Late or Missed Payments Due to Lack of Funds
Making minimum payments isn’t necessarily bad if you aggressively tackle debt reduction using snowball or avalanche methods. Missing or late payments because you don’t have enough money to meet your financial obligations is the beginning of a downward financial spiral that only worsens over time.
The credit card debt cycle can be difficult to break, especially for people on a fixed income who can’t afford to make larger monthly payments to reduce outstanding balances. To eradicate yourself from the cycle, start using cash for the majority of your purchases, spend wisely and avoid unnecessary purchases, track your spending habits, and get rid of any cards that don’t have balances so you aren’t tempted to use them.
With some time and a heaping of self-control, you can break the credit card debt cycle.
Take Control of Your Credit Card Debt and Start Paying It Off Faster
Most credit cards come with high annual percentage rates that are north of 20%. If you are only making minimum monthly payments, your credit card balances will take much longer to pay back, and you’ll pay much more in monthly finance charges.
Debt consolidation is an excellent tool to get rid of high credit card debt. If you have good credit, you can likely get approved for a debt consolidation loan with a much lower interest rate. You’ll have regular monthly payments and a firm end date. If you can’t secure favorable loan terms, a balance transfer to a zero- or low-interest credit card might provide some much-needed breathing room (for a short period of time) and allow you to pay down your credit card debt.
