Using credit cards have become an essential part of everyday life for many consumers. With the widespread use of the plastic, handling emergency situations, giving in to that occasional buying impulse, or even meeting everyday needs has become so much easier.
But if you think that simply paying the affordable minimum balance today and making it up with bigger payments in the future when everything would hopefully have righted itself is the practical way to go, you have another think coming. That’s exactly the kind of thinking that got a lot of people mired in credit card debt, leaving them now with few options as to how to get out of it.
Understanding the minimum payment calculation
What most consumers often don’t realize is that the high interest rates and low monthly minimums of credit cards are designed in such a way that if you aren’t too careful, even with prompt minimum monthly payments you’ll still be doing your credit more harm than good. So before you go and dig yourself a hole from using the plastic, it’s important to understand how the minimum balance is calculated.
Different credit card companies have varying methods of computing the minimum monthly payment. It could be within the range of 1% – 5% of your outstanding balance plus finance charges. And with today’s skyrocketing APRs, you can be sure that majority or at least half of your payment would go to interest charges instead of diminishing your balance.
Say for instance, you have a credit card carrying a $1,000 balance, and you are required a minimum monthly payment of 2.5% of that balance. If the APR of that card is 18%, that’s in effect a 1.5% finance charge per month. So if you deduct that 1.5% finance charge on your outstanding balance from your $25 payment ($1,000 x 2.5%) for that month, you would essentially have paid $15 on interest and $10 only the principal.
Assuming you make no other purchases and no changes will be made on the interest rate of your card, and if you continue to pay only the minimum monthly payment asked of you, it would take you 12 years and 9 months to pay off the balance. But what’s even more noteworthy is reality that you would have paid about $1,115.41 in interest for an original $1,000 balance.
While this may seem acceptable to you, think how much worse the situation could be if you were tempted into paying a lower minimum or if you carried a balance of more than $1,000, which is highly likely. And that’s not yet taking into account the higher APRs and fees imposed when you make a cash advance on your credit card.
Consider the bigger picture
While it’s more convenient and seemingly easier on the pocket to just go with the minimum payments set by your credit card issuer, in the long run, it’s not in your best interests to do so. You’ll be paying for so much more than the amount you actually used.
The merits of putting in a few dollars or tens of dollars more for your monthly payment on the other hand, are quite apparent. From those few dollars you pay over the minimum, you’d be saving yourself hundreds in interest payments, plus the fact that you’d get yourself out of debt sooner. In addition, the lower your outstanding balance compared to your credit limit is, the better your credit score will be, consequently increasing your chances of being approved for mortgages and other types of loans.