If you feel like you’ve paid off yourbalance forever, you may have only made minimum monthly payments. Your minimum payment is the lowest amount your provider will accept each billing cycle.
While minimum payments avoid late fees and missing payment reports to credit bureaus, it usually won’t pay off your credit card balance anytime soon (depending on how much you owe). It’s important for credit card users to understand how minimum payments work so they can make the best decisions about paying off their debt.
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How are minimum credit card payments calculated?
The minimum payment is the lowest amount you can pay in a given month to avoid penalties and fees. Credit card companies typically use four different methods to calculate minimum payments, which depend on the credit card’s balance and interest rate. Here are the ways yours could be calculated.
Percentage of your balance: If you owe a large amount of money on your credit card, your minimum payment will likely be around 2-3% of your balance, Debt.com Resident Expert and CPA Howard Dvorkin told CNET. However, it could also be as low as 1%.
“Credit card companies make more money when the minimum payment is lower, so more money goes to the interest rate and less to the principal,” Dvorkin explained.
Percentage of balance plus interest and fees: Some credit card companies calculate your minimum payment by combining a lower percentage of your balance – often 1% – plus interest and fees from the previous billing cycle.
Package: If the outstanding balance on your credit card is relatively low, your minimum payment may be a fixed amount. There is no standard among credit card companies, but from a survey of eight major credit card issuers, we found that flat rates range from $20 to $41.
Full payment: If your balance is less than what the credit card company would charge as a flat rate, say $15, your minimum payment will likely be the total balance for that month.
Your minimum payment and how your credit card company calculates it should be included in your credit card agreement.
How can I find my credit card agreement and what does it contain?
Your credit card agreement will include an explanation of exactly how your minimum payment will be calculated.
“Every credit card company is mandated by law to give you the credit card contract,” Dvorkin said. You can request the agreement by e-mail, postal mail or find it on your bank’s website.
The Consumer Financial Protection Bureau also houses a library of thousands of current credit card contracts of all credit card companies with more than 10,000 accounts, as required by the Credit Card Accountability and Disclosure Act of 2009.
Here’s what else you can find in your credit card agreement:
- What you can buy with your credit card: for example, a store credit card versus a MasterCard or Visa
- Your credit limit and how it might change
- Your annual percentage rate (APR or your interest rate) and how it might change
- Foreign transaction fees
- How your minimum payment is calculated
- How to pay your bill
- How your credit card use is reported to the credit bureaus
- How your personal information is shared
- What changes your issuer is allowed to make to your terms and conditions
- How your credit card company defines default and what it means
- What to do if you lose your credit card
- Info on closing your credit card account
- What to do in the event of a billing dispute
What happens if I don’t make the minimum payment each month?
If you don’t pay the minimum amount each month, credit card companies will consider this a missed payment. In this case, you could be charged late fees or incur an APR penalty, which is a high interest rate triggered by late payment. The credit card company may also report your missed payment to all three credit bureaus. When this happens, the damage to your credit can last up to seven years.
And the effects can continue to worsen: “When you pay late, credit card companies can hit you with higher interest rates that won’t come down,” Dvorkin said.
If you can’t make the minimum payment, contact your lender as soon as possible to discuss your options. For example, if you’re waiting for a paycheck to make your credit card payment, see if you can extend your due date past payday. You can also ask your credit card company if they offer relief programs.
Why should I pay more than the minimum monthly payment?
Depending on your APR and your balance, most of your monthly minimum payment is probably spent on interest and not on paying back your principal. To put more money on your principal debt, you will have to pay more than the monthly minimum.
Credit card law requires creditors to provide details in each monthly statement about how long it will take to pay off a balance if you make only the required minimum payment, and how much interest accrues during that time. . This disclaimer should also include the monthly amount needed to pay off your balance in three years and the total amount it would cost using that monthly payment.
Your credit card statement will also include the interest portion of your balance, your principal balance, and the APR that calculates the interest on your balance.
Dvorkin advises against paying only the minimum amount each month. “It’s a trap to keep you in debt,” he said. When you only pay the minimum amount, it may result in increased interest and it may take longer to pay off your total balance.
Let’s break it down. If you owe $10,000 on your credit card with an interest rate of 18% and make minimum monthly payments of $200 (using 2% of the balance), you will need more than 50 years to pay off your debt. During this time, you will have paid an additional $28,397 in interest. That’s almost triple the amount you originally owed.
Since your minimum payout is based on a percentage of your balance here, as your balance decreases, your minimum payout will also decrease. Make a fixed paying $200 to pay off your $10,000 balance would take less than eight years and cost you $8,622 in interest. That’s nearly $20,000 in savings.
If you cannot pay your bill in full each month, Capital One suggests pay as much as possible of the balance. Paying even double the minimum amount can help significantly.
Using the previous example of a balance of $10,000 and an APR of 18%, if you pay double your minimum of 2%, or 4% of your balance each month, it would take you 13 years and half to pay off your debt, but you’ll only pay $5,874 in interest.
“The higher your outstanding balance, the more interest you’ll pay, which can make it even harder to get out of debt,” said Colleen McCreary, consumer finance advocate at Credit Karma.
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