Escaping a Credit Card Minimum Payment Trap

Each month you can make minimum payments on your credit cards – the lowest payment amount you are allowed to make every billing cycle. It may be tempting to end the month with a little extra cash in your hands, but is it worth the headache down the line?

If you only make minimum payments on your credit cards, it can take years if not decades to pay off even a modest balance. Why? Because your credit card issuer or bank charges interest until your balance is fully paid off. Even though paying the minimum is enough to get you by, this isn’t the path we want you going down. Here’s why…

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What are credit card minimum payments?

A credit card minimum payment is the lowest amount a lender or credit card issuer will accept monthly as payment. Although it is not required you pay off your balance in full each month, it is always a good idea because you’ll avoid accruing interest charges.

Credit cards are a form of revolving credit – a credit account that you can repeatedly use and carry over a “revolving” monthly balance. So, your payments are calculated based on your monthly balance. Making minimum payments can give consumers time to help pay off balances. But once interest starts accruing and your balance increases, it will become more difficult to pay off. In the meantime, you waste a ton of money.

For this reason, experts advise cardholders who carry balances to stop charging and focus on paying off their current balances instead.

How are minimum payments calculated?

Each credit card company has its own minimum payment policy. Generally, required minimums are a small percentage of your balance, plus interest and additional fees. Or it can be calculated as a flat percentage of your card’s total credit balance.

You can find out how your minimums are calculated in your cardholder agreement. If you are having trouble finding the information, you can always call your issuer for more details.

Here are the two methods banks or credit card companies use to calculate minimum payments:

Flat percentage

Certain credit card companies calculate minimum payments as a percentage of your total balance that is usually between 1%-3%.

Example: Say your current credit card balance is $2,000 and the minimum payment is calculated at a 3% rate. Your minimum would be $60.

Balance percentage, plus interest and fees

Other credit card companies calculate your minimum payments by calculating your statement balance plus any interest and fees accrued during that statement period.

Example: Suppose your statement balance is $2,000. The issuer calculates minimum payments as 1% of your credit balance plus interest and fees. Now, assume during this time you also accrued $45 in interest and $35 in late fees. After calculations, you would be looking at $20 (1% of $2,000) plus the $45 interest and the $35 late fees, which comes out to a $100 minimum payment.

A minimum limit for minimum payments

Most creditors also have a minimum limit of the minimum payment. For instance, your minimum payment will almost fall below $35. For example, if your balance is $100 and you are on a 2% payment schedule, your minimum payment would technically be $2. But instead, your minimum payment ends up being $35.

At a certain point, your remaining balance becomes your minimum payment

In cases where your balance is lower than the credit card company minimum payment limit, your remaining balance will be the minimum.

For example: If your monthly minimum payment limit is $35 and your current balance is $25 balance, then your minimum for the month would be your remaining balance of $25.

Why making minimum payments on credit cards keeps you in debt

Credit card minimum payments are not designed to help consumers get out of debt quickly. They are designed to keep you in debt longer so the credit card company or bank can make profits. We use our credit card payoff calculator to give you an example of how long it would take to pay off debt.

You could be paying for years

When you make only the minimum payment due on your credit card, the credit card issuer isn’t doing you a favor by making that payment amount so low. Paying only the minimum payment may give you some financial breathing room temporarily, but the longer you take to pay off the balance, the more you will pay in the long run.

How much will you pay? It’s easy to find out by looking at your credit card statement, since the card issuer is required to include a minimum payment disclosure of the approximate amount you’ll pay over time if you make only the minimum payment and how long it will take to pay off the balance.

For example, if your credit card has a 15.99% APR, the balance is $2,000 and you make only the minimum payment amount of $20 a month, it will take more than 30 years to pay off the balance. If the minimum payment on that same balance is $60, it will take more than ten years to pay off the card.

Find out: Explaining What APR is and What Does it Mean to Your Debt?

You’ll pay a high price for the minimum payment option

If you pay only the minimum on a card with a 15.99% APR and a $20 initial minimum payment, you’ll pay more than $20,000 over 30 years to pay off the balance. If the minimum payment on that same balance is $60, and that’s all you pay each month initially, it will take more than ten years to pay off the card, and you’ll pay a total of around $3,300 over 10 years. As your balance decreases, so will the minimum payment amount, which extends the length of time it takes to pay off the balance.

Find out: How Credit Card Interest Works

You have a greater chance of maxing out your card

When all you make is the minimum payment each month on a credit card, your chances of maxing out the card increase. That’s because the balance remains high due to making small payments. So, as life throws curve balls such as car repairs, home repairs, medical or veterinary bills and other financial emergencies your way, you may have to charge those expenses to the card, too.

Maxing out your credit card raises your credit utilization rate, potentially lowering your credit score. And the higher the balance, the longer it will take to pay it off, especially if you’re paying only the minimum payment every month.

Paying off a $2,500 credit card balance with minimum payments

Imagine you have $2,500 in credit card debt and a 17% APR that you want to pay off with minimum payments. If your credit card has a 3% minimum payment schedule, your first payment would equal $75. Should you continue paying only minimums, it would take 9 years and 7 months (115 payments) to pay off the debt. You would pay a total of $4,293 with 58% of payments going toward the principal debt ($2,500) while 42% goes to the $1,793.66 in accrued interest.

As you can tell, the interest rate is holding you back from paying off your credit card debt. Hence, it makes more sense to pay off a card when you can or pay a little more each month to keep interest minimized. Otherwise, your minimum payments only end up covering your accrued monthly interest.

Will making minimum payments hurt your credit?

While making on-time payments reflects positively on your credit report, credit scores can still be negatively affected by minimum payments. How? Since you would take longer to pay off the credit card debt, your credit utilization may suffer over time.

So long as you are making your minimum payments each month, you continue building consistent payment history. And that reflects positively on your credit history.

It is important to note that monthly payment amounts do not directly impact your credit score. Instead, minimum payments influence the amount of credit you are using, also known as credit utilization. That’s because your credit utilization rate – the percentage of your revolving credit to total available credit – accounts for around 30% of your credit score. This means that as your credit card utilization climbs, your credit score falls.

Ideally, you should keep your credit utilization rate below 30%, according to major credit bureau Experian. For instance, if your total credit card debt is $5,000, and total available credit on all your cards is $10,000, your credit utilization ratio would be 50%, which is too high and can lower your credit score. However, if your total revolving debt is only $2,000 in that scenario, your credit utilization rate would be only 20%.

Although minimum payments won’t directly affect your credit score, they can indirectly hurt your score if you are trapped in a minimum payment cycle. This debt cycle will increase your credit utilization rate, which conversely depresses your credit score.

And if your score continues to suffer, you could be hit with a credit limit cut. So, even if you never miss a payment, the fact that you have high balances could spook a lender. And if they see you as a liability then they will reduce your credit limit. In turn, the credit limit reduction will harm your credit utilization rate and lower your score even more.

What credit card companies are required to tell you about minimum payments

The Credit Card Accountability Responsibility and Disclosure Act of 2009 (The Credit CARD Act) was put in place to protect consumers against unfair credit card industry practices. Prior to its conception, credit card issuers or banks raised consumers’ interest rates without notice. They were also imposing unlimited fees, including but not limited to late fees and over-limit fees. Often, card issuers approved transactions above consumers’ credit limits so they could take advantage of over-limit fees.

Today, the Credit Card Act provides consumers with many protections, such as providing regulations for disclosures on your credit card statements and/or the original agreement. They must also include a minimum payment warning that cautions consumers on the pitfalls of making minimum payments, as well as the length of time it would take to pay them back.

Additionally, near the minimum payment requirement statement they will list:

• The number of payments it would take to bring the account current while following the minimum payment schedule.
• The total cost to pay off balances, including interest plus principal balance, if no other purchases are made.
• The monthly payments required to eliminate the credit card debt in a 36-month timespan.
• A toll-free number for information about credit counseling and debt management services.

Credit card statements must also include a due date for payments, or they must include the date late fees would be applied to that account. And if one or more late payments will result in a penalty interest rate, then it should be explicitly stated.

How to escape the minimum payment trap

The minimum payment trap creates a false sense that you’re in control of your finances. In reality, minimum payment traps keep you in debt longer. And though you may avoid late fees by paying minimums, you still accrue interest on your remaining balance.

Paying your balances in full will benefit you in the long run far more than paying required minimums will. If you are only making minimum payments, you will continue maintaining a high balance for longer even if you stopped making credit card purchases. Paying your full balance while maintaining a zero balance on your credit report will lower your credit utilization and boost your credit score. If you pay it off in full every billing cycle, you’ll also never pay interest charges.

And if you cannot pay off your balance, then avoid making any additional purchases on that card while paying more than the minimum. This will help you catch up on your debts a little quicker and it will help you avoid accruing more interest.

The surefire way of getting out of debt is through creating and sticking to a budgeting. So, if finances are a little tight for a couple of months and you cannot pay your balances in full, we recommend sitting down and creating a budget. Creating a budget will give you an indication of when and where to make cutbacks. For example, maybe consider alternating between streaming services or canceling a few altogether.

What to do if you can’t get out of a minimum payment trap

If you are finding it more and more difficult to get out of debt, it may be time you consider credit counseling. Finding a credit counselor who works for a nonprofit organization would be best. Why? Because they will not drive you to one solution. Nonprofit credit counseling services focus on giving consumers impartial views of their finances to help them find the best debt relief solutions.

FAQs about minimum payments