The Secret Behind Your Credit Card’s Minimum Payment
If you currently use a credit card, you know it’s mandatory to pay a certain amount every month. This amount is called the minimum payment, which represents the least amount of money your creditors will accept for the balance you have that month. This amount varies depending on your credit card provider and can be presented as either a fixed amount or a percentage of the balance. However, just because there is a minimum payment, it doesn’t mean you should only pay that amount.
Is cancelling a credit card bad for your credit score? Find out here.
Why Does My Credit Card Have a Minimum Payment?
Banks create a minimum payment requirement for credit card holders for a number of reasons. Firstly, it demonstrates that the lenders are responsible and reliable people who will make timely payments. Secondly, it shows that they have the means and are capable of paying off the loan. Lastly, creditors want you to pay this minimum amount in order to extend the length of the loan and make more money. The smaller the monthly payments, the longer it will take you to get out of debt. By lengthening the time it takes to pay back the loan, banks can earn more in interest. Unless your credit card charges you 0%, your interest charges will significantly increase the balance your carry over time. Therefore, you should pay as much as you possibly can, if not the full amount, every month.
Credit Card Interest Rates
An interest rate is a quantity, expressed either as a percentage or fixed amount, which is charged by a lender to a creditor for borrowing money. When taking out a line of credit at the bank, most credit cards come with an interest rate charge, payable every month. If you pay the least amount every month, the outstanding balance will be pushed to the future months. During these months, you accumulate and pay interest on the full amount you borrowed. Considering you use your credit card regularly and your balance keeps growing, so will the interest charges. This is a vicious cycle that just gets you deeper and deeper into debt. In order to avoid this, pay off as much of the balance as you could each month so only a small amount, or even better no amount, gets carried over to the next month and you get charged interest on it.
This is the interest paid based on the principal amount of the loan, plus the accumulated interest from the past periods. Every time your outstanding balance for the month gets pushed to the next month, you paid interest on the full amount. The more it gets pushed, the more you pay. That’s why it’s good to pay as much as you can right away. Compound interest can be thought of as interest on interest, where you’re paying for interest on the original amount plus interest that you owe each month.
Essentially, you’re being charged double the interest because of the length of time it takes you to pay. This will make the overall amount owed rise to a much higher amount than it should be.
How to Responsibly use a Credit Card
It is important to remember that having a credit card doesn’t mean you have money. Having a credit card actually, means you owe money.
In order to use your credit card responsibly, follow these suggestions.
- Pay the full amount of your outstanding balance
- Pay your credit card bills on time
- Work on building and increasing your credit
- Don’t make impulsive purchase decisions
- Don’t use your credit card like a debit card
- Don’t let your friends use your credit card
- Don’t exceed your budget
- Track your spending/cash flow on a weekly basis
- Before you press accept, ask yourself do you need it or do you want it? If the answer is, want, don’t purchase it.
How Does a Credit Card Affect Your Credit Score?
Your credit score is a number representing your credit worth and ability to pay back a loan. This score fluctuates depending on certain purchasing behaviors and actions. Failure to pay your credit card bill on time or with the minimum amount will result in a decrease in your credit score. However, by paying on time and in full (or the minimum amount), your credit score will increase proving you’re responsible and worthy of a line of credit. It gives you the opportunity to work on improving your credit history and increasing your eligibility. Thus, it’s clear that having a credit card can be good or bad for your credit score, it just depends on how you use it.
Check out this infographic for more information on what affects your credit score.
Minimum Payments and How They Create a Cycle of Debt
What causes the debt?
Debt is caused by numerous factors and behaviours, but we mainly focus on the combination of overspending and high-interest rate charges. If you constantly delay payments to the future and create a buildup of interest charges while your expenses remain the same or increase, you will find yourself in debt. When minimum payments are made and a large portion of the money is being pushed to the following months, you have to pay interest on the full amount you borrowed every month. Remember, you have to pay extra to borrow money from the bank. If you weren’t able to pay your full bill last month, what makes this month any different? If you can’t afford to pay the entire balance and only pay the minimum amount, it will increase to the point will you’ll never be able to pay it back. At the end of the day, people are in credit card debt because they’re spending more than they can afford.
What Effect Does Credit Card Debt Have On Your Financial Life?
Being in credit card debt puts your financial life in jeopardy, as you owe money to the bank that you don’t have. This is stressful and can take a huge toll on your life, as it impacts the way you live on a daily basis. Not only do you currently owe money, but you’re also spending money every day, increasing this amount every day. You have to make a serious change in your financial life and cut your expenses. You simply can’t afford to buy what you used to. Additionally, when you’re in debt, all your discretionary income will be going towards interest, so you can’t even enjoy what your money is actually able to buy. You have to give up personal spending money to pay for interest. Keep in mind, having excessive amounts of debt also lowers your credit score, thus losing your creditworthiness and taking away your ability to borrow money. Now, interest rates will be higher than usual. Lastly, being in credit card debt means putting a hold on your social life as well. While you should be in intense saving mode, you can’t financially afford to go out drinking, shopping, or eating in restaurants.
How To Get Out Of Credit Card Debt
- Consolidate all your debts into one single loan at a lower interest rate
- Stop using your credit card
- Cut your expenses
- Make arrangements to pay a certain amount every month and stick to it
- Follow a budget
- Ensure you’re not late or miss any payments and pay the amounts in full
- Consider getting a second job
How To Prevent Yourself From Creating Credit Card Debt Again
To prevent yourself from getting back into credit card debt, you must be extremely strict and disciplined with yourself. Knowing you have an easy time slipping back into debt, you should be cautious with every purchase you make. Always ask yourself, do you need the item or do you want it. Cutting your expenses is important, but you must also remember to be smart with your credit card payments. Don’t fall behind on payments and don’t pay the minimum amount. Try to get a low-interest credit card if yours is currently excessive and follow a budget. Be frugal, be smart, and even be cheap.
Click here to learn how to consolidate your credit card debt.
Credit Card Definitions
Monthly balance: Your credit card monthly balance is the amount you owe at the end of the month. This includes how much money you put on your credit card bill (current outstanding balance plus any interest charges from previous months).
Minimum payment: This is the minimum amount you must pay your creditors every month, which is derived from a percentage of the outstanding amount. Paying only the minimum can greatly increase the time it takes to pay off your credit cards.
APR Interest Rate: This is the annual interest rate that banks and creditors use to charge people for borrowing money. This rate is applied yearly and is expressed as a percentage of the cost of the funds.
Balance Transfer: A Credit card balance transfer includes moving the outstanding balance of the debt from one card to a new credit card. This is usually done when customers want to move their current debt to another credit card with a lower interest rate and better benefits.
Cash Advance: This is a common term for saying a short-term loan from a bank or other lenders. This service allows credit card holders to withdraw a predetermined amount of cash, at a higher interest rate.
Billing Cycle: This is the timeframe between billings each month, as in when you receive your credit card bill.
Secured Credit Card: This is a type of credit card that’s secured by a sum of money which would be used as collateral in case you were unable to continue making payments.