Credit cards can be a slippery slope for some. Learn the do's and don'ts of making your monthly payments.
Article: 9 minutes
Updated: July 18, 2024 Published: October 24, 2022
By: Josh Andrews, CFP® Reviewed by: Editorial contributors
While credit cards themselves are not inherently good or bad, they can be a useful tool when used wisely. But issues can arise when balances begin to mount up. Whether it's a result of overspending or unexpected costs outside of our control, credit card debt can be a major source of stress in our personal lives and relationships. It can also be a barrier to achieving other financial goals like owning a home, starting a business or saving for retirement.
Combatting high credit card interest rates starts with understanding your bill each month. When you get a credit card statement, do you only pay the minimum amount due? If so, read on to fully understand the financial impact of making “only minimum payments.” We'll show how much credit card interest can truly cost you.
The first thing that's important to learn is the difference between your credit card statement balance and the minimum payment.
Your statement balance is the total amount you owe, including any interest accrued. It's the amount you must pay to set your balance back to zero.
The minimum payment is how much you must pay each month to avoid penalties, like fees or, in some cases, increases to your credit card interest rate. Not all banks increase your interest rate for missed or late payments but some might. The reason behind minimum payments is to make sure you're making progress toward paying off your debt, instead of letting it continue to grow indefinitely.
Minimum payments are often calculated as a certain percentage of the overall balance that must be paid each month. But each credit card company may have different ways of calculating the minimum payment, and it can change based on how much you owe.
For example, you may be asked to pay a certain percentage, like 1% to 3%, of the balance, plus interest and other fees or charges. If your account is past due or you're over your allowed limit, it may include other fees or charges in your minimum payment amount.
Many companies also have a floor set on their minimum monthly payment amount, which sounds more confusing than it is. Let's say your total balance owed is $100 and your credit card company has their minimum payment set to 3% of the balance. That would be $3. But the company might have a $25 minimum monthly payment amount, in which case, you owe $25 — even though that's much more than 3% of your balance.
If you're not sure the terms of your credit card, you can find them in the cardholder agreement you received when you opened the account. If you don’t have it handy, you can download it from your credit card company's website or ask them to mail you a new one.
There are so many variables that make up your credit score that it's difficult to isolate the impact of just making minimum payments on your credit card.
However, some of the factors that contribute to your credit score can be affected by how much you choose to pay each month, and how much it impacts your credit score can change based on which methodology you’re looking at.
Your payment history makes up 35% of your overall FICO® score but accounts for 40% of your VantageScore®. Making at least the minimum payments each month means you're not missing payments. Missed payments may stay on your credit report for up to seven years, which would negatively impact your score.
Credit utilization, which accounts for another 20% to 30% based on the methodology, is the amount of credit used in relation to your available credit. Making the minimum payments means your balance is only decreasing by a small amount, so your credit utilization stays higher than it would if you're making more substantial payments.
Let's say two people, Amelia and Brett, both have a credit limit of $10,000 and no other debt or available credit. Amelia has a balance of $2,000, for a 20% credit utilization rate. Brett has a balance of $9,000, for a 90% utilization rate. Choosing to make only the minimum payments will probably have a higher negative impact on Brett’s credit score than Amelia’s as he’ll likely have a higher credit utilization for a longer period of time.
The most important thing to remember is that making a minimum payment is better than not paying at all. Take some time to understand the factors that affect your score by learning how to establish and maintain good credit.
The best way to use a credit card is to pay the balance down to zero each month, so you avoid paying interest on your purchases, assuming no cash advances or other transactions that accrue interest differently. This is a good way to build credit over time and stay financially flexible. It also helps to make sure you don't put any charges on the credit card that aren’t already within the budget and within your ability to repay.
When you only pay the minimum amount due each month, the rest of the balance remains and accrues interest. The longer your balance goes unpaid, the more it grows because the remaining balance accrues interest.
Paying only the minimum amount due on your balance each month can have two major effects. It increases the time it takes you to pay off your debt, and it increases the amount of interest you end up paying — sometimes by a lot.
Rather than doing the math yourself, you can use a credit card calculator to explore options for paying the balance off.
Let's say that you've decided to take the family on a Hawaiian vacation with a total cost of $10,000. Instead of saving up for the trip, you put it on a credit card and pay it off over time. Let's also say that your minimum monthly payment is 2% of the balance, and you don't put any other purchases on the credit card. The table below shows how long it will take, and how much it will cost to pay off the full balance with different payment amounts.
As you can see, making only the minimum payment means years to pay off the debt and costs you significantly more in the long run. Thirty years is a long time to pay off a vacation that lasts only a week or two. Imagine what you could do with that $15,573 you'd spend in interest. Is it worth it to take the relaxing vacation now, even if it causes years of debt-related stress?
You may be wondering why it takes so much longer to pay off the balance by making only the minimum payment and why it's not a set amount each month. As the balance decreases, so does the minimum payment. The initial minimum payment in our example is $200, which is 2% of the $10,000 balance. But when you've paid the balance down to $5,000, your minimum payment now becomes $100. That's because it's a percentage of the balance and not a set monthly amount. As you pay down the balance, the payment gets smaller, which is why it takes longer to pay off.
Even if you just continue to pay that initial minimum payment of $200 per month, left it at that and didn't decrease your payment amount as the balance decreases, you'd pay the balance off 23 years faster and pay about $9,700 less in interest. That's a big difference and illustrates the financial impact of only making minimum payments.
There may be times when you just can't afford to pay more than the minimum payment. A decrease in income, for instance, may hinder your ability to pay back the credit card balance that you were on track to pay down.
If you're unemployed or underemployed, paying only the minimum on your credit card could help you maintain some flexibility while you get back on your feet. When you have a steady income again, you can resume your debt paydown strategy and go back to paying more than the minimum payments.
How you'll go about wiping out your credit card debt depends on your personal financial situation, but there are some general considerations for those who are unsure of where to start.
If your credit card debt is due to excessive spending, rather than emergency costs outside of your control, the first step is to spend less than you earn. Spend less than you earn by having and sticking to a budget.
You'll also want to make sure you have an emergency fund in case something comes up. If you don't, you'll likely just end up relying on your credit card again. Save for an emergency fund through a dedicated savings account.
One way to reduce the amount of interest you’re accruing as you pay down your debit is to transfer your balance to a card with a lower annual percentage rate. To learn more, read When to consider a balance transfer.
Some people choose to take out loans at lower interest rates. This option can be especially helpful if you're paying off multiple cards. It'll require some research to find out if debt consolidation will benefit you. If you go this route, make sure the terms of your new loan are favorable to you and beware of loans that have penalties for paying them off early. Check out this information if you're considering a personal loan to pay off debt.
If you still feel overwhelmed by credit card debt, there are resources that can help you. One good place to start looking for a trustworthy credit counselor is The National Foundation for Credit Counseling (Opens in New Window). See note 1
If you're in the military, you have even more options for support. Reach out to the organization that's affiliated with your branch:
Put simply, paying only the minimum amount due each month is an expensive way to pay down your credit card balance. Sometimes it's your only choice, but it can often be avoided if you use credit responsibly, maintain a budget and spend less than you earn. If you can't avoid the debt, make paying it off a priority. Your future self will thank you.
Plus, make sure you're in the right card for you. It doesn't make sense to be in a high-rate rewards card when you’re paying interest month to month. The interest rate is possibly offsetting any benefit you receive from the rewards. You possibly could be in a lower rate card with no rewards instead.
Learn the do's and don’ts of balance transfers.
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