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How is the monthly minimum payment calculated for credit cards?

By , CardRatings Contributor

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How is the monthly minimum payment calculated for credit cards?

The answer to this question is often a mystery to consumers. The reason is because the details of this calculation is hard to find in credit card offers, if you can even find it at all.

According to the Federal Reserve Bank of Philadelphia, the minimum payment is typically the greater of 2.5 percent of your outstanding balance, or $15. To confirm the percent used for the minimum payment calculation, check your cardholder agreement. If it isn't explained in the agreement, call your card issuer and ask how the minimum payment is calculated.

Let's take a look at a simple example to see how this works. Suppose you have an outstanding balance of $1,000 with an interest rate of 12 percent, which gives you a monthly interest rate on your outstanding balance of 1 percent. Yes, I picked 12 percent to make the math easy!

If your issuer uses 2.5 percent to calculate the minimum payment, then your minimum payment will be $25 ($1,000 x .025), and this includes interest expense of $10 (1,000 x .01). Note that for the first few months you're only paying $15 toward the principal if you stick with the minimum monthly payment. In fact, after the first year, you will have paid $110 in interest and only $190 of the principal amount. This means you still owe $810 on your original $1,000 balance.

If you pay only the minimum amount every month, it will take you 52 months to pay off the debt and you'll pay a total of $283 in interest charges. The CARD Act requires issuers to show on your monthly statements how long it will take to pay your debt if you make only the minimum payments. Seeing how much interest you'll end up paying can certainly motivate you to pay your debt off as quickly as you can.

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