The minimum payment on credit cards is the lowest amount of money you can pay each month. Until the year 2004, minimum payments could be as low as 2%.
But credit card companies were forced to change under pressure from federal banking regulators because account holders could end up paying for large purchases over decades and still not pay off the account balance.
Currently, industry standards require the minimum payment be calculated in one or two ways:
- A percentage (3% to 5%) of the total current balance; or
- All fees and interest plus 1 percent of the principal amount owed which is why the minimum payment can change from month to month.
The minimum payment decreases as the credit card balance decreases; however, due to compounding interest, you can end up paying for a longer period of time if you pay only the minimum.
The result means you pay 2 to 3 times the amount for your original purchase. That really nice dinner you treated your family to, may take several years to pay off.
The Card Act of 2009 has forced credit card issuers to disclose to account holders the consequences of paying only the minimum amount due. On credit card statements you'll notice a space for how long it would take to pay off the entire balance if account holders made only the minimum payment.
Credit card companies must also disclose information on how much account holders must pay each month in order to pay off the account balance in 36 months.
Major risks of paying just the minimum due
Credit Score Decrease
The credit scoring formula calculates amounts owed as 30% of your total credit score. Your credit score could suffer if you have several credit card accounts with balances or if you are using a high proportion of your credit card limits and only paying the minimum required payment.
If your credit card balance is close to the credit limit and you only pay the minimum payment, you are doing nothing to put a dent in the amount of your debt. The credit scoring model likes to see high credit limits along with low account balances — UNUSED CREDIT LIMITS.
Consumers may think banks only want you to pay the minimum in order to bring in more revenue; however, consumers who routinely make minimum payments are a red flag to most banks. They may assume some type of financial distress is occurring; and, you may become a risk.
The bank may even lower your credit limit which could be detrimental to your credit score because the credit utilization (ratio of credit limit to credit balance) would increase. The higher your credit utilization, the lower the credit scores.
Credit cards are not part of your income and definitely not meant to supplement your income. There are some instances where paying only the minimum payment is acceptable such as periods of unemployment or an emergency such as an illness.
Credit cards are a convenience and not a way to purchase items you cannot afford. While credit cards offer flexibility with both spending and repayment, they can also become an albatross.
Through no fault of their own, consumers often fail to realize how difficult it can be to pay off credit cards, especially those with high-interest rates and balances. You may be paying a $2500 credit card balance for the next 20 years if only the minimum payment is made.
Rack up interest charges
Credit card interest charges continue to grow along with credit card balances unless you’re using a 0% APR card. The minimum payment will barely decrease the previous month's interest. Not to mention if you keep charging items to the card, you’ll be facing an uphill battle, falling further and further behind.
If you have credit card debt, use the minimum payment option only as a tool when needed. Otherwise, pay more than the minimum to avoid long-term credit card debt. Another alternative would be to reduce credit card debt altogether with a debt consolidation loan.
Whatever you do, never pay less than the minimum due on credit cards, that could end up with the credit card company charging-off your account. Charge-offs are major credit score killers.