Credit Cards: Minimum Payments Mean Maximum Cost

credit-card-mousetrapMaking minimum payments on a credit card can keep you in debt for decades. Why so long?

The answer lies in the payment formulas used by credit card lenders. Most cards use one of two methods to calculate the minimum payment. Some banks require you to pay a percentage of your balance every month. With other issuers, you have to pay a percentage of the balance plus this month’s interest. (Of course, the interest charge is itself a percentage of the balance.)

Either way, your credit card’s minimum payment keeps going down as your balance goes down. So even though you’re always making some progress, you keep losing steam over time. This is very different from a mortgage or car loan, where the minimum payment is usually the same amount every month, and later payments actually pack a bigger punch.

Minimum Payment Case Study

Let’s look at some numbers from an actual credit card statement:

  • Balance: $4,536.84
  • Annual Interest Rate: 20.99%
  • This Month’s Interest Charge: $78.33
  • Current Minimum Payment: $123.00

With these numbers, we see this bank calculates the minimum payment by taking 1% of the balance and then adding this month’s interest charge. (The full formula is a bit more complicated, but for blog purposes, “1% of the balance plus interest” is close enough.)

If you keep paying the minimum every month, how long would it take to pay off this card? An online credit card payment calculator gives us the answer: 25 years and 10 months. Over that time, you’ll pay the bank $7,519.25 in interest charges, more than the current balance!

What Would Paying the Minimum Cost You?

You can use the same online calculator to find out what minimum payments on your cards will cost, both in time and money. Also, thanks to the Credit Card Accountability Responsibility and Disclosure Act, all consumer credit card bills must now contain a “Minimum Payment Warning” with the same information. This is just one of the many consumer protections provided by the Credit CARD Act.

Knowledge is power, even if minimum payments are still as weak as they’ve always been.

Matt Conrad is an Indianapolis bankruptcy attorney and the founder of Conrad Legal LLC, which helps people in Central Indiana get out of debt with Chapter 7 and Chapter 13.

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