All the Ways Minimum Payments Are Evil
Anyone who has a credit card is familiar with minimum payments. Most credit cards don't require cardholders to pay off their balances in full every month, but they do require cardholders to pay some minimum amount. This can be as low as 2% to 3% of the outstanding balance, or a minimum of $25 or $35 — whichever is higher.
While paying the minimum technically keeps your account in good standing, there are negative consequences to this decision. Here are five reasons why minimum payments are evil and should be avoided.
They Keep You in Debt
Minimum payments may keep your credit card bills affordable, but you have to consider the big picture. In the end, minimum payments don't benefit your bottom line — they benefit your credit card company.
The truth is, minimum payments are a sneaky trick designed to keep you a slave to credit card debt. The longer you keep a balance on your cards, the more money your creditors earns off you. If you only pay your minimums every month, you'll carry your balances for years to come. For example, if you have a credit card with a $2,000 balance and 17% interest rate, and you only make minimum payments each month (2% of your balance), it will take you over 21 years to pay it off. You'd have paid over $3500 in interest alone — and that's if you don't put additional purchases on the card.
That may seem like a shock, but that's exactly why the minimum payment schedule was designed. Because they're taking a percentage of your balance, every month, the minimum payment required goes down. That does two things — encourages you to pay less so that you keep the balance longer, and it also tricks you into thinking that you're actually making progress paying off your debt. If you see that your payments are getting lower, you feel like your debt is getting smaller too. But you're actually hardly chipping away at the debt at all.
If on the other hand, you pay $50 per month, it will take you five years to pay it off, with about $970 in interest. That's a huge difference compared to 21 years and $3500 in interest. Every little bit of extra you can put into your credit card debt will significantly cut down on your repayment time.
If you can make reasonable plan and keep to your budget, a balance transfer will put a pause on interest payments and help you pay off debt faster.
Purchases Become More Expensive
Credit cards might be convenient, but they're also costly — and unfortunately, if you carry a balance from month-to-month and only make the minimum payment, you end up spending much more for every purchase made with the card. And once you leave a balance on your card, the grace period disappears and you immediately start accruing interest the moment you make your purchase. Grace periods are only active if there is no outstanding balance. (See also: Everything You Didn't Know About Credit Card Interest and Grace Periods)
If you have to make a large purchase, you can get a card with a 0% introductory APR on purchases. For a certain period, no interest is charged on your outstanding balance. This gives you time to pay off the purchase without interest. However, once the intro period is over, the regular APR will kick in. It's important to only use that opportunity if you know you can pay off the balance during the introductory APR time period.
Your Credit Score Can Suffer
In my younger days, I thought as long as I paid my minimum payments on time, my credit score was protected. I was young and dumb and didn't realize how other factors impact credit scoring.
Paying only the minimum may not have a direct negative impact on your score, but it doesn't exactly help it, either. A high credit card balance can result in a higher credit utilization ratio, which is the percentage of outstanding debt in comparison to your available credit line. Credit utilization is the second biggest factor making up your credit score, and if your credit card balances exceed 30% of your available credit, your score will take a hit.
You can lower your credit utilization ratio — and subsequently improve your credit score — by paying more than your minimums every month. Minimum payments are just that — minimums. Even if you only double or triple your minimum, this will chip away at what you owe and reduce how much you pay in interest significantly.
It Affects Other Areas of Your Financial Life
Paying only the minimum might not seem like a big deal, until you realize how this decision can impact other areas of your financial life. If you're only making your minimum and carrying a high balance on a credit card — resulting in a lower credit score — this affects the ability to get other types of financing. If you apply for a mortgage or an auto loan, lenders will take one look at your high balances and low score and consider you a risky applicant. There's a chance you won't qualify for some loans, or the bank might not offer favorable terms.
Minimum Payments Can Increase
Another problem with minimum payments is that they aren't carved in stone. Credit cards are a revolving type of credit account. As your balance goes up, so does the amount you owe. Your minimum payments might be manageable today. But if you continue to charge to your account and don't make any efforts to significantly decrease the balance, your minimum payments can increase. If you're already struggling with your budget just to meet the minimum payments, the most important thing is to sit down and make a debt repayment plan. Otherwise, you'll be stuck in this cycle of debt for generations.
Do you pay the minimums on your credit cards?
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Tagged: Debt Management, APR, credit score, credit utilization ratio, interest rates, minimum payments
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