The Truth About Minimum Payments
Why You Should Avoid Minimum Payments Each Month + Ways to Pay More
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In order to maintain good credit, one of the most important things you can do is to pay your credit card payments on time each month. It may seem like a good idea to only get the minimum payment covered, possibly if you’re low on money at the time. While it’s alright to make minimum payments every so often, they can actually end up doing more damage long term.
How is a Minimum Payment Calculated?
The minimum payment issued by a cardholder is based on the current balance of a card and its rate. The amount of the minimum payment may vary each month, depending on the balance and any additional fees or charges from the period before.
3 ways a minimum payment could be calculated:
- Flat percentage of the cardholder’s balance: This rate may be a few percentage points of the total balance. The minimum payment will vary based on the size of the balance.
- Percentage of the cardholder’s balance with interest and fees from the prior period: The card issuer can charge 1% of the balance plus the cost of any interest or fees from the last monthly period.
- Flat rate: The card issuer may charge a simple flat rate as low as $35 due every month. The minimum payment will be the entire balance if the balance is below the flat rate.
Consequences of Minimum Payments on Credit Cards over time
In order to avoid further damage to your credit in the long run, check out the major risks of only making minimum payments on your credit card each month.
Interest Charges Will Increase
When you carry a balance on your credit card each month, you’ll be required to start paying interest charges. The problem becomes even bigger when you continue to charge the card, and the amount you will have to pay each month along with interest charges will only increase. If you’re curious about your own interest charges and how significant they might be, divide your card's annual percentage rate by 12 and then multiply that number by your average balance.
For example, if your card has a 21% APR, your monthly interest rate would be 21% divided by 12. Finally, multiply that by the balance you’re carrying! Overall, the lower balance you have on your credit month to month the better. Start paying more towards those payments and enjoy having less debt.
Credit Scores Will Be Damaged
Your credit utilization ratio can be a heavy factor that goes into determining the status of a credit score. The credit utilization ratio refers to the percent of credit you’re using. When you only make the minimum payments each month, your credit utilization ratio will continue to stay high. If you feel low on cash whenever it’s time to pay some of your bills, focus on your credit card bill and getting it taken care of soon after you get paid from your job.
With all of the expenses we have to manage each month, it can be stressful getting everything paid on time let alone making higher payments than need be! However, it’s important to remember how important a credit score can be when it comes to things like buying a first home or car. Do whatever you can to keep your credit score in the best standing possible!
Longer to Pay Off
When paying just the minimum payment on your credit card each month, you’re prolonging how much time it will take for the card to be paid off. Take a look at your credit card bill, and you may notice a “minimum payment warning.” You may see a table that shows you how many years it’ll take to pay off your balance by only making the minimum payments every month.
Think of it this way, if you pay closer to twice the amount of your minimum payment each month, your repayment period will be cut in half. While it may be unrealistic for many to pay that much more, even a few dollars on that minimum payment will help speed up the process over time!
Tips to Help You Pay More than the Minimum
These strategies may help you come up with that extra cash to add on to those monthly payments!
Know Your Debts
If you don’t know where you can stand with your credit card debt, now is the time! Check your statement and look at the total amount that you owe. Look at some of your other monthly debts, like a mortgage, loan, or phone bill. Finally, look at your monthly income versus the amount of debt you owe. You can find out how much more money you have to pay towards that minimum payment, and you can start looking for ways to save money if need be.
Establish a Budget
The 50/30/20 rule is a common strategy that many people use to budget. The rule consists of 50% needs, 30% wants, and 20% savings or debt. This rule is a fair way to keep track of your spending habits, and can even help you find areas where you might need to work on spending a bit less.
Examples of Needs:
- Car payment
Examples of Wants:
- Going out to eat
Major ways to save:
- Emergency fund
Avalanche Payment Approach
With the “avalanche” approach, you’ll be paying down those credit cards with the highest APR (annual percentage rate) first. Continue to work your way towards paying off cards with the next highest APR and so on, and you’ll be saving a good chunk of money by lowering those interest payments.
While tempting, try to avoid settling for the minimum payment on your credit card(s) each month. Interest will only increase, your credit scores will be damaged, and you’ll only spend more time paying on those same cards. Adjust your budget, and set yourself up to succeed in the long run.
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