Don’t Get Sucked Into the Minimum Payment Trap!

Credit card companies LOVE the minimum payment. Why? Because a customer who pays the minimum payment on their credit card bill will likely NEVER (or almost never) pay off the balance, which means more interest for the credit card company.

How does the minimum payment work?

The minimum payment is usually 2% (there’s talk of it moving up to 4% but I haven’t seen that happen yet) of the outstanding balance. So, if you have a credit card with a $5,000 balance, your minimum payment would be $100. As long as you didn’t charge anything else to this credit card and you paid your bill on time, your balance would go down by the payment amount minus any interest charges for that month. So, the next month your minimum payment would be 2% of the remaining balance, which means it would be a smaller payment. The problem with this, as I stated above, is that a smaller payment means it will take longer for you to pay off your bill, which means you will pay more interest to the credit card company. To illustrate, take a look at a couple of scenarios:

Scenario 1

Beginning Balance of $5,000
Annual Interest Rate of 12%
Minimum payment percentage of 2% of the outstanding balance
Interest is calculated once per month (to keep things simple), making the periodic interest 1% (12% &#247 12 = 1%)
Nothing else is ever charged on this card

Take a look at what happens at the end of five years:

Paying the Minimum Payment on a Credit Card

Assuming all the information above, at the end of five years you would still owe over $2,700 on this credit card if you only paid the minimum payment each month. What’s worse, your TOTAL payments over those five years are only about $500 shy of your beginning balance, illustrating just how expensive interest can be.

Scenario 2

Beginning Balance of $5,000
Annual Interest Rate of 12%
Payment is a CONSTANT $100 per month
Interest is calculated once per month (to keep things simple), making the periodic interest 1% (12% &#247 12 = 1%)
Nothing else is ever charged on this card

Now take a look at what happens at the end of five years:

Paying $100 Per Month on a Credit Card

WOW! See what a difference it makes? Over the five years you would have paid $1,472 more in payments but you owe $1,819 LESS! That’s a pretty nice trade-off if you ask me. Sure it’s nice to get that credit card statement and see that you only have to pay a certain amount. However, that minimum payment comes at a very high cost!

The point of all this? Don’t fall for the minimum payment trick. Instead, pay as much as you can, as often as you can. You’ll be happy you did.

7 thoughts on “Don’t Get Sucked Into the Minimum Payment Trap!”

  1. I’ve seen what you wrote about in practice myself. My balance almost never seemed to go down because after the interest payments I would only be paying 20-30$ down.

    I’ve gone to a steady $125 per pay accelerating the reduction, this worked really well and I got used to the money leaving right when I got paid.

  2. We have a second checking account that’s just for bills and a portion of each of our checks automatically goes into it. We’ve decided how much we want to pay towards our credit card debt each month and we keep that constant, no matter the minimum payment (paying off the highest balance first).

    The point is that by making it automatic we really don’t miss it!

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