More Than the Minimum

You’ve been making your monthly credit card payments, but you just can’t ever seem to get ahead. Sound familiar? For consumers, it’s easy to think of a minimum payment as monthly payment.

Most credit card issuers only bill you a minimum payment. But they’ll continue to charge you interest on the balance, and that could cost you hundreds, even thousands, of dollars. What is the minimum payment on a credit card? It’s the minimum amount of money your credit card company will accept to maintain your account and avoid any late fees.

Paying the credit card minimum payment will avoid that fee but you’ll still have to pay interest on the balance, calculated based on your average balance over a 30-day period then multiplied by your interest rate. Depending on your total debt, the monthly minimum payment will usually be a flat payment, say $25, or up to 3% of your balance, whichever is greater.

But if you’ve charged $30 to your card, paying just $25 may keep your creditor from calling but it still puts you behind on your total debt. Continuing this practice month after month can leave you owing much more than your original charges, essentially trapping you in perpetual debt.

Say you carry a balance of $5,000 and your interest rate charged on the balance is an adjustable 23%. Making only the minimum payment, it will take as long as five years for you to pay off and you’ll have paid nearly $8,000 in interest!  Put another way, carrying $5,000 on your card could cost you almost DOUBLE that amount in accrued interest. That new pair of shoes you bought on sale for $75 now cost you almost $300 by the time it is paid off.

Since 2009, credit card statements have been required to share the payoff timetable based on your interest rate and balance. In the first column, you’ll see how long it will take to pay off your balance, plus the total interest. In the next column, it will demonstrate the savings of making more than your minimum payment. You’ll see that even adding another $50 will clear that balance faster – plus save you all that interest!

Carrying a balance on your credit cards can have a huge impact on your credit score, as well. A 2013 study from credit bureau TransUnion found that credit card users who consistently made only the minimum monthly payment had higher delinquency rates than those who paid more than the minimum or the entire balance every month. Capital One, the third-largest credit card issuer in the U.S., adds this: “Credit card companies usually report account activity — including payment information whether late or on time — and balance each month to the credit bureaus. While each of the major credit bureaus — Equifax, Experian and Transunion — has its own score model, the less you owe and the more on-time payments you make, the better that is likely to be for your credit score.”

Like all things financial, paying off your debt is a personal journey so there may be times when it isn’t advisable to pay more than your monthly minimum payment:

• If you owe taxes or are behind on child support payments it might be better to retire those debts first. Why? In both cases, your creditor can garnish your wages, freeze accounts or worse. Any of these punitive acts can turn your molehill of debt into a mountain of financial ruin. It may be best to ensure taxes and other liabilities are met before tackling credit card debt.
• Another event that could put your debt retirement into a tailspin is a major emergency. That could be anything from an unexpected and expensive car or appliance repair to a health crisis. Without at least a small emergency fund, you might need to run up more debt on a credit card, putting financial freedom further out of reach. If you have less than $1,000 in savings, you might want to set aside savings for the unexpected.
• You might also consider first addressing very high interest loans such as a payday loan; outstanding medical bills; or personal loans from friends or family.

Once those big bills are paid off or your emergency fund is set, then it’s time to dive back into making more than your minimum payments. Having a strategy – and sticking to it – will help.

Here are two approaches to consider:

The Snowball Method

If your debt is spread out over several credit accounts, start by paying as much as you can toward your lowest balance. You’ll find when you add funds to the minimum payment, your debt is paid off pretty quickly. When that account is paid in full, add the total amount you paid to your payment toward your next lowest balance (minimum payment + additional amount toward account 1 + minimum payment toward account 2 = early payoff for account 2)! Continue rolling over your extra payments into your next highest credit balances and in no time, you’ll have retired all of your debt.

 The Avalanche Method

If you’re confident you can pay off your entire debt within five years, paying off credit balances with the highest interest rate first might be a better approach for you. If you can afford the time, applying a hefty amount of cash toward high-interest accounts will save you money over time.

In either approach, the more you pay the less you’ll pay! What’s that? Adding as much as you can to your minimum payment will either decrease your total debt or you’ll retire the high-interest debt sooner, both saving you tons of money in accrued interest.

Ultimately, you can only eliminate your debt by not racking up new debt so if you can avoid it, don’t purchase anything more on your credit cards. This is why that emergency savings is so important. Unless it’s absolutely critical and your savings won’t cover an emergency expense, avoid bringing out your credit card until you’ve retired the debt.

Partner with Vantage Acceptance: Tackling debt is never easy, but a thoughtful plan will help. A smart option is to consult with a credit consolidation company, such as Vantage Acceptance. We have effective debt reduction options and have saved our customers thousands of dollars in principal and interest payments. Find out more with a no-obligation call to one of our advisors at (800) 725-0214.