Have you been paying the minimum amount due on your credit card month after month? If so, the balance you owe the credit card company continues to grow as you continue to spend. When you’re paying only the minimum due, it can feel like you’re barely making progress toward paying it down.
And, with the holidays just around the corner, you might be planning on buying holiday gifts on your credit card or would like to increase your cash flow by paying the minimums on your cards.
Unfortunately, paying the minimum amount due means you will be paying hundreds of dollars on your credit card bill every month and those credit card balances won’t go away.
What Happens When You Only Pay the Minimum?
If you pay only the minimum due, you still owe the credit card company money because you didn’t pay the total balance. Depending on how much you owe, paying the minimum might only be enough to cover the accumulated interest and a small portion of the balance.
That’s right. You might not even be paying for the stuff you bought. You might only be paying the interest your card issuer is charging you for the stuff you bought.
Let’s look at an example.
Unless you have a very low balance, the minimum payment due is typically a percentage of the total amount you owe—usually 2%-4%.
Every month when you make a payment, part of your payment gets applied to the interest that’s accumulated, and part gets applied to the principal. The principal is the amount you paid at the store or online for your purchases.
Let’s assume you have a credit card with a balance of $4,000 and an APR of 24.75%. If the initial minimum payment due is $125, $83.34 of your payment gets used to pay for the interest you got charged that month. And the remaining $41.66 gets applied to the principal, leaving a balance of $3958.34.
That means more than half of your payment is being used for interest before you start chipping away at the principal balance. The payments get applied the same way every month until your balance reaches $0.
Now, as your balance decreases, your minimum payment will too. And that’s where people get into trouble. In fact, if you continue to pay only the minimum, it’ll take about 21 years to pay off the $4,000 balance, and you’ll pay $7,311.34 in interest.
That’s because the minimum payment is used mostly to cover the interest charges you owe the card issuer.
And that’s if you don’t use your card to make any more purchases. If you continue to use your card, the amount you owe will increase, the amount of interest you pay will increase, and it’ll take even longer to pay off.
Imagine if you bought all your holiday gifts on your credit card. By paying the minimum due on your credit card, you’ll be paying for those gifts for a very long time. That also means all the work you put in to get a good sale price on the gifts will be at a loss because you’ll be paying extra in interest each month for those sales.
What Happens When You Pay More Than the Minimum?
But if you pay more than the minimum, you can take years off your repayment timeline.
And here’s the thing. You don’t have to come up with hundreds of extra dollars each month. Using the example above, if you add just $10 more than the minimum due to your payment each month, you’ll cut your repayment timeline from 21 to 12 years. That’s nine years earlier! And you’ll reduce the amount of interest you pay by almost $2,500. (See the chart above again to illustrate this point.)
Now, what if you could commit to making the same $125 payment you made during the first month (when that was the minimum due) every month until you pay off your balance?
Then it would only take about 4.5 years to pay off the $4,000 balance, and you’d only pay $2,661.02 in interest. That means you’d save about $4,650 on interest charges. Imagine what you could do with that extra money.
But even if you can’t pay that much each month, every little bit you can pay above the minimum helps you pay less interest and become debt-free faster.
Why Paying More Than the Minimum Matters
Paying the minimum, so you have extra cash left over to spend on other things may seem like a good idea. But maintaining high-interest credit card debt is robbing you of the money you’re trying to hold onto. If you have a balance on your credit card, the best financial move you can make is to pay it off as quickly as possible.
That’s what will put more money back in your pocket by reducing the amount of interest you pay and what will help you achieve your longer-term financial goals faster. Just think about the thousands of dollars you could save in interest by paying just a little more than the minimum due each month in our example above.
The amount of interest you can save and your repayment timeline will vary based on how much credit card debt you have, what the APR is on your card and how much you pay each month.
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Smart Moves to consider doing instead of paying your minimums:
1. If you have money in a savings account that you can withdraw without penalty and you feel confident in your employment situation, consider using the cash to pay off your credit card.
By making this trade off, you will be able to save more in interest paid (credit card interest) than you will make on interest earned (savings account interest). Then, build your savings back up by saving what you would have paid to your credit card each month. A zero-balance credit card can also get you to stop spending on your credit card altogether.
2. Budget to pay more than the minimum on your card(s) each month.
You can pay it all by your payment due date. Or, you can have a weekly budget to add more to your card each week. Similar to the tip above, maybe you can start to shift your savings account deposits to your credit card bill each month.
3. Do not use your credit card on holiday gifts or meals this season.
We know that buying big priced tech items and new designer spoils seems like a good idea around the holidays, but you will be paying a much bigger price tag by adding it to your card. Try to let go of the belief that big priced items communicate your value or love for people. Take a chance on only using your cash on hand for gifts this season. You may be surprised at how well it goes.
4. Try this fun spending habit: For every holiday coffee or treat you buy yourself, open up your credit card app and pay $5 on your credit card. This way, any time you’re treating yourself, you step it up a notch by also treating yourself to lower debt.
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