Credit Card Minimum Payments Have Fallen (and That’s a Bad Thing)
As Claire Tsosie recently pointed out in Forbes, a minimum of 5% was the norm back in the 1970s. However some card issuers have since lowered that percentage to a mere 2% of your balance or, in some cases, 1% plus new interest. So why is that bad thing? Here are three reasons.
It will take you much longer to pay off
Obviously when you’re making smaller payments on your debt it will take you longer to pay it off. How much longer? If you paid the 2% minimum with a floor of $25 — meaning that’s the smallest dollar amount you can pay, even if it’s more than 2% — on a $10,000 credit card balance with a fairly average interest rate of 16%, it would take you a whopping 394 months to pay off. That’s over 32 years!
As for the 1% plus new interest model, it does help some but would still have you making payments for 287 months or nearly 24 years. Meanwhile 5% minimums with the same floor would get you out of debt in 104 months. At over 8.5 years, it’s still not a short amount of time but at least it’s better that three decades of debt.
Smaller minimums mean more money for card companies
Since creditors make money off of interest paid on debt, paying only 2% a month instead of 5% means you’ll end up spending a significant amount of money on fees. In fact the difference can be pretty shocking. Going back to the previous example of the $10,000 balance, paying the 2% minimum would mean you end up spending $18,323 in interest — and that’s not including the principal! That’s a huge difference compared to the $3,540 you’d pay with 5% minimum payments. Still, the faster you can pay down your balance, the better.
Your credit scores could be affected
Part of the reason people may make only the minimum payments on their credit cards is so they can keep current on their account and avoid going into collections. That is to say they’re trying to prevent hurting their credit scores. Unfortunately carrying a high balance on your card for a long period of time can do some damage as well. That’s because a good chunk (30%) of your FICO credit scores consider credit utilization, meaning the amount you owe compared to how much credit is allotted to you. As a result using more than 30% of your available credit could bring your scores down. Plus keep in mind that the idea of needing to keep a balance on your card in order to earn credit is a myth. One more reason to pay off your balance ASAP.
Paying a smaller minimum on your credit card might seem like an appealing proposition until you consider what that path might lead to. Not only will making smaller payments keep you in debt longer and require you to pay way more in the end but could also hurt your credit scores, leading to more issues down the road. Ultimately it’s important to overcome the temptation of credit card minimums and pay off your debt as quickly as your can regardless of what the card issuer requires.