Making full payments to credit card balances can be challenging from time to time, particularly when you have multiple bills due around the same time or your pocket is tight.
You may have noticed that each credit card bill includes a minimum payment amount, which is just a fraction of the balance. You might wonder if it's ok to make only the minimum payment. The short answer is yes, but the short-term relief comes with consequences.
Sounds horrible? Once you understand how the minimum payment scheme works, you will be shocked at the colossal debt that one partially repaid credit card balance can snowball into in the longer term. In this blog, we will walk you through what's behind the concept of credit card minimum payments and how they may erode your credit profile in the long run.
Minimum Payment Defined
The minimum payment is the lowest amount you need to pay your credit card issuer each month to keep your account in good standing.
Credit card companies have different ways to calculate minimum payments. Typically, the minimum payment is around 2% of your entire balance, but you may find the method that applies to your card in the credit card agreement.
What Happens When You Make Only the Minimum Payment?
Making minimum payments is indeed preferable to missing credit card payments. A missed payment will not only hurt your credit score, but also incur a late fee if you are a first-time offender. As bad as it can become in the long run, paying the minimum payment can help you avoid the late fee and keep your account in good standing. At least that's what happens in the short term.
As we mentioned, it's important to note that paying the minimum on your credit card can result in extra interest charges compared to paying full balance due. Given that the average credit card interest rate in the United States can reach as high as 22%, this can easily cause your interest costs to accumulate much more rapidly than expected.
How High can the Monthly Interest Charges be When You Make Only the Minimum Payment?
Thanks to the Credit Card Accountability Responsibility and Disclosure Act of 2009 that Congress passed in 2009, you can now easily find out how much you will owe the credit card company by paying the minimum.
The law requires all consumer credit card issuers to include a minimum payment warning in each monthly credit card statement. The warning informs you about the time it would take to pay off the outstanding balance as interest cost accumulates and the total amount you would need to repay based on the applicable annual percentage rate (APR) and your statement balance.
In short, minimum payments have the potential to snowball into a credit card debt that can take decades to repay, and the interest charges may be even exceed the principal balance.
How Can a Minimum Payment Affect Your Credit Profile?
In addition to paying extra money, a credit card minimum payment can also negatively impact your credit score. For a better understanding of the mechanism, let's take a step back to examine the elements that determine your credit score, or FICO score.
Credit scores can change based on your credit behaviors reported to the credit bureau. Typically, your credit score is influenced by several factors, such as:
- Payment history: Payment history is one of the most crucial factors in determining your credit score. It reflects whether you make your payments on time, including credit card payments. Missing or making late payments can have a detriment impact on your credit report. Minimum payments generally can prevent late payment reporting to credit bureaus and protect your credit score to certain extent.
- Credit utilization ratio: This ratio, which compares your credit card balances to your credit limits, is the next most important factor. Making only the minimum payment can cause your credit utilization ratio to increase, negatively affecting your credit score.
- Length of credit history: This refers to the length of time you have held credit accounts.
- Types of credit: Having different types of credit, such as credit cards, loans, and mortgages, can positively contribute to your credit score.
Obviously, when you opt to pay the minimum amount indicated on your credit card statement, you are putting your credit score at risks of a substantial loss of points. On the contrary, making a full payment on your credit card on time eliminate the risks associated with late fees, interest charges on the remaining balance and potential negative effects on your credit score.
What can you do to avoid making only minimum payments?
When you found yourself struggling to pay the full statement balance or even unable to make the minimum payment, it may indicate a lack of an effective budget plan that allows you to avoid impulsive spending. With living cost spiralling up across the nation, your financial situation may further deteriorate if you don't improve your budget management.
Making an effective budget is the first step towards a more healthy financial status, ensuring that you have enough funds to meet all kinds of financial obligations, including credit card debt. During the process, you will have the opportunity to review all your expenses, identify areas where you can cut back on costs, and find suitable ways to increase your income or save money.
If you are experiencing a difficult time due to whatever reasons, try seeking help from charity organizations or government assistance programs for financial or other forms of support. This will provide you some relief and avoid creating more debt by paying only the minimum amount.
For example, you may qualify for a FREE smartphone, and cheaper internet and mobile phone services in Oklahoma, if you meet specific requirements of the Affordable Connectivity Program (ACP) and Lifeline Program. These two programs aim to provide affordable and high-qualify communications services for low income families and individuals.
Qualified participants of the ACP can receive a monthly discount up to $30 on broadband service (up to $75 if you live on qualifying tribal lands). While the Lifeline provides a monthly discount of up to $9.25 on phone services (up to $34.25 for those live on qualifying tribal lands).
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