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Why You Should NEVER Pay The Minimum Payment - And 3 Times When It's Ok

When you get your credit card statement, you’ll see 2 numbers.

The first is your credit card minimum payment, which is the least amount of money you need to pay on your credit card.

The second is your statement balance, which is the total amount of money you owe to your credit card company.

There will be a large difference between those two numbers. Your statement balance is whatever you spent, so depending on your level of spending it could be anywhere from $100 to $1,000 or more. Your minimum payment will seem tiny in comparison, and could be as little as $10.

It can be tempting to pay only the minimum since it looks like so little money, but that decision could end up costing you big time. Outside of a very few specific circumstances, you should never pay only the minimum payment on your credit card.

 

How is the minimum payment calculated?

Every major bank uses the following calculation to determine your minimum credit card payment:

$10 + any interest + any fees

The box that shows you this is shown before any credit card application, and looks like this:

If you always pay off your credit card, your minimum payment will be just $10, no matter how large your balance was. That’s great for freeing up cash, but it could be extremely costly the next month when interest is applied.

Some smaller financial institutions use a calculation that’s based on a percentage of your balance instead. The percentage could be 1 – 3%, but will usually have a minimum amount such as $40 as well. That would be inclusive of all fees and interest.

 

Why is paying the minimum a bad idea?

The best way to use a credit card is to pay it on time and in full every month. You’ll build your credit score by having a history of no missed payments and you’ll avoid all interest charges and fees, except your credit card’s annual fee.

If you have fallen into credit card debt, the best thing you can do to get out of it is to throw as much money as possible towards your debt. The sooner you reduce your debt, the less interest you’ll have to pay.

The absolute worst way to get out of credit card debt is to make only the minimum payments. The amount of time it takes to get out of even a small balance can be astronomical.

By law, credit card companies must disclose how long it would take you to pay off your credit card statement if you were to make only the minimum balance. You’ll find the disclosure on your credit card statement. Here’s one from a statement of mine, for reference:

The balance on the statement was just $400. It would take over 3 years to pay off just $400. In that time, it would have cost me $130 in interest, which is 32% of the original balance.

As you can imagine, larger balances take a lot longer to pay off at only the minimum payment. If I started with a balance of $1,000 instead of $400, the time to pay off jumps to 8 years and 4 months. A balance of $5,000 would take over 41 years.

 

Even small amounts can save you hundreds of dollars

You may pay the minimum payment because your debt feels so insurmountable there’s no point in paying more. I’m telling you that it does matter. Even as little as $1 more per month (yes, really just $1) can you save money.

On that $400 balance, adding just $1 more will reduce your repayment time by 3 months. $5 more will reduce it by 13 months. $10 more will reduce it by 20 months!

The higher your balance, the larger an effect a small payment will have.

 

$1,000 Balance

Monthly Payment

Months to Pay Off

Months Saved

Money Saved

Minimum Payment

107

0

$0

$1 more

97

10

$75.71

$5 more

73

34

$277.61

$10 more

57

50

$416.46

 

$5,000 Balance

Monthly Payment

Months to Pay Off

Months Saved

Money Saved

Minimum Payment

501

0

$0.00

$1 more

455

46

$1,892.97

$5 more

334

167

$6,940.94

$10 more

251

250

$10,411.46

 

3 Time It’s Ok To Make Just The Minimum Payment

At the beginning of this post, I mentioned that in some instances it’s ok to pay the minimum payment. You can see that it’s always more expensive to keep paying the minimum, but sometimes it’s unavoidable – or even in your best interest – to pay the minimum.

 

1.     When you have debt across multiple cards or loans

There are two competing strategies when it comes to debt elimination – the debt snowball and the debt avalanche. The avalanche is the mathematically superior option, but the snowball claims to have more success.

The two strategies are very similar. They both have you cut down all your debt payments to their minimums then put all your extra money towards one of them. In the avalanche, you put your money towards the highest interest debt first. In the snowball, you put it towards the loan with the lowest balance.

Let’s examine how much both of the strategies would cost, using the following debts as an example.

Loan

Balance

Interest Rate

Minimum Payment

Credit Card 1

$2,200

22.99%

$40

Credit Card 2

$800

19.99%

$40

Line of Credit

$1,500

9.99%

$50

Car Loan

$13,000

5.99%

$300

Student Loans

$10,000

7.25%

$120

Total

$27,500

 

$550

 

 

For the avalanche, you would pay the debts in the following order:

  1. Credit Card 1 – 22.99%
  2. Credit Card 2 – 19.99%
  3. Line of Credit – 9.99%
  4. Student Loan – 7.25%
  5. Car Loan – 5.99%

When one loan is finished, you take the money you were paying on that loan and immediately add it to the next payment. In this way, your total monthly payments always remain the same.

For this example, we’ll say you have an additional $250/month to use towards debt payments, for a monthly total of $800. If you followed the avalanche method, you would be debt free in 38 months and have paid a total of $3,078 in interest.

With the snowball, you’d pay them off in this order:

  1. Credit card 2 - $800
  2. Line of credit - $1,500
  3. Credit card 1 - $2,200
  4. Student Loan - $10,000
  5. Car Loan - $13,000

In the end, you’d be debt-free in 42 months and have paid $3,728 in interest. That’s 6 months longer and $650 more in interest, but you may be more likely to follow through with your plans this way. The idea is that if you get the motivation of paying off small loans you’ll continue the momentum with your big loans.

 

1.     When you have a 0% balance transfer

0% financing is a great way to spread out a larger purchase so it doesn’t shock your budget. Because of inflation, 0% interest is actually cheaper than buying something in cash, as future dollars are worth less than current dollars, but the number you owe doesn’t change.

A 0% balance transfer credit card allows you to move a balance from a high-interest credit card to one with no interest. You then have a limited time to pay off the balance before interest starts again.

If you can repay your total balance by the time your balance transfer ends, you’ll have saved a lot of money. If you can’t, you’ll have to start paying interest on the remaining balance, and the interest rate may be higher than your old card. Balance transfer interest rates are nearly always higher than purchase rates.

When you have a 0% offer, you still have to make monthly payments, but interest stops building up. If you miss a payment, your rate immediately goes back up to normal – so if you can’t make the whole payment, be sure to at least make the minimum.

 

 

2.     When not having cash would force you to take a payday loan

The maximum legal interest rate for any loan in Canada is 60%. Anything beyond that is called “usury.”

Payday loans, however, have an exception in the law, and can have annual percentage rates as high as 391%!

Credit cards may have high interest at 19.99%, but payday loans should be an absolute last resort, even if it does mean paying just the minimum on your credit cards.

 

 


Chris Chris 01/26/2019
Canadian personal finance buff and all-around writing enthusiast, Chris loves breaking down complicated money ideas to show that they're really not so complex. 
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