In my three and a half decades of using credit cards, the sheer amount of misunderstanding around minimum payments has been astonishing. Despite hearing claims that it’s crucial for credit building or a perk of card ownership (both false!), the reality is that the minimum payment is just the bare minimum you must pay each billing cycle to avoid a late fee. Relying on it, however, can lead to a substantial build-up of interest.
Many consumers are shocked to discover the significant interest charges they incur by consistently paying only the minimum balance. This article aims to clarify how minimum payments truly function, empowering you to become a savvy cardholder by minimizing interest and maximizing cash flow. My goal is to underscore the considerable risks of relying solely on minimum payments.
How are credit card minimum payments calculated?
When you get your bill, you have more than likely noticed the minimum payment due is significantly lower than your actual balance (the total of all the charges on your card). The difference between the minimum amount due and your full balance can be vast.
You may be wondering how your card issuer determines your minimum payment. As with many things involving credit, the answer is that it often varies by card company, but the formula is typically pretty similar. For example, Capital One states in their terms and conditions:
“If your balance is less than $25, your minimum payment will be equal to your balance. Otherwise, your minimum payment will be the greater of $25 or 1% of your balance plus new interest and late payment fees. We will also add any past due amount to your minimum payment.”
Capital One’s policy is fairly typical, but again, calculations can vary. In another example, Citi uses a $41 baseline when calculating their minimum instead of the $25 amount that Capital One uses.
What is a minimum credit card interest charge?
Some issuers also charge a “minimum interest charge” in addition to a monthly minimum payment. These are two different charges but they sound similar, so the differences can be confusing to consumers.
A minimum required interest or finance charge is a fee charged if the interest due on your outstanding balance in a month falls below a certain amount, typically around $2 or less.
This fee will not normally affect you if carry a larger balance as you will likely pay much more in interest than the minimum charge. However, if you carry a small balance (under $100 or so) you may get dinged.
Gerri Detweiler, a credit expert and author of “The Ultimate Credit Repair Action Plan,” explains that it’s fairly common for “issuers to charge a minimum interest charge. If your total interest falls below that threshold, you’ll still pay that minimum interest charge.”
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Some issuers don’t charge this fee, including cards issued by some credit unions. So be sure to check the terms and conditions of your card to determine if there is a minimum charge and, if so, how much.
How much interest do you pay by only making minimum credit card payments?
One of the many real benefits of having a credit card is the grace period, which allows you to avoid interest charges for a certain amount of time after your billing cycle ends, typically 21-25 days. As long as you pay your balance in full each month, you can enjoy the cash flow benefits of your card’s grace period each month (and never pay a dime of interest).
Unfortunately, paying the minimum forfeits your card’s grace period and interest or finance charges start to accrue once making a minimum payment. According to Detweiler, “card issuers typically charge interest on your average daily balance. This means you may pay more interest than you expect.”
➤ LEARN MORE:How your credit card average daily balance impacts interest rates
Here’s a real-life example from Detweiler that helps explain how even paying way above the minimum can result in high-interest fees:
- Your card statement arrives in the mail and shows your full balance due is $1,000 and your minimum payment required is $10.
- You are a bit strapped for cash, so you pay $800 thinking you’ll only be charged interest on the remaining $200.
- But, depending on the timing of your purchases, your average daily balance will likely be much higher than the $200 remaining balance.
- And since you’re paying interest on the daily balance and losing your grace period, all charges may incur interest.
Perhaps the most sobering result of losing your grace period, though, is that any future purchases you make (on the next billing cycle) will rack up interest immediately. I love the analogy that Lynnette Khalfani-Cox, also known as The Money Coach, uses to explain this:
“Paying just the minimum is like trying to empty a bathtub with a teaspoon while the faucet is still running!”
To put it more bluntly, she adds that the long-term effects of only paying the minimum on credit cards are often devastating:
“Those minimum payment amounts are carefully calculated to keep you in debt for decades. With today’s high interest rates pushing 30% to 32% (or more) on some cards, a $3,000 balance could take over 20 years to pay off and cost you nearly three times the original purchase price. That ‘affordable’ $90 minimum payment is really just an expensive rental fee for money you’ve already spent.”
BONUS TIP!
Only about 1-3% of your minimum payment goes toward reducing your principal balance – the rest is just feeding interest to the card issuer. Think of your principal balance as the original purchase amount you charged on your card. If you’re strapped by card debt, consider these tips on paying down debt.
Strategies to avoid only paying the minimum on credit card debt
Understanding the dangers of minimum payments leads to the crucial question: how can you avoid them when facing financial difficulties? Fortunately, effective strategies exist to accelerate debt repayment without overwhelming your budget. Here are some of my top recommendations:
1) Biweekly payments– As mentioned above, paying even a little over the minimum can yield big interest savings. A related strategy involves making biweekly payments. My colleague Carley Clark offers the following explanation of how this clever approach works:
“Say you owe $5K on a credit card with a 17% interest rate and a 3% minimum payment. If you only send in the minimum amount every month, by the time you’ve paid off that $5,000, your interest bite would be $4,119. It would take 14 years to pay off your total tab of $9,119.
“However, simply sending in half of your minimum payment every 14 days can help you pay your debt off more quickly, with less interest. In the example above, you would cut your interest bill by $2,521 and could be debt-free in three years and 18 weeks instead of 14 years!”
The savings are even more dramatic if you have a lower minimum payment requirement, particularly if your minimum is only 1% of your balance.
➤ FREE TOOL:Credit Card Interest Calculator
2) Early card payments- On a related note, if you don’t want to use the biweekly approach and you’re not paying your balance in full each month, it can be helpful to make your payment earlier rather than waiting until the due date. Even paying a few days before your due date may help save you interest.
3) Two-card strategy- Detweiler suggests that if you know that you won’t be paying your balance in full that you consider getting two cards. You can use one card for purchases you won’t pay off in full and another card for ones you will pay in full every month. That can help you avoid interest on purchases you plan to pay off which could result in big savings over time.
4) Consider a 0% card offer- Intro 0% APR rates on purchases and balance transfers are a proven way to lower card debt. These cards allow you an interest-free period to pay off new purchases or transferred balances. As long as you pay off your balances in full before the introductory period expires, you can avoid paying interest on those products for a period of time.
Final thoughts on minimum credit card payments
Paying only the minimum on your card(s) is not a death sentence and certainly beats not paying at all. However, it is a sentence to a “debtor’s prison” of sorts. The good news is that making small efforts to pay above the minimum can yield big returns. It might not have the allure of stock market gains or the buzz of Bitcoin, but focusing on debt reduction offers a surefire way to save money, a stark contrast to the unpredictable nature of investments.
