Paying The Minimum On A Credit Card

Making the minimum payment on your credit card will keep the account current and in good standing. But consider paying off as much of your balance as you can each month. The lower your balances, the better your credit health.

When it comes to paying off your credit card balances, you have multiple options. Paying the minimum on a credit card can be tempting. Why pay more if you don’t have to? If times are tough and you’ve been relying on your credit cards to help you pay other bills, it’s understandable if you feel you can only afford the minimum payment temporarily. Paying the balance in full, however, is best when you’re able. It may help prevent your credit score from lowering and can save you money in the long-term.

How are credit card minimum payments calculated?

The minimum payment for credit card accounts can vary from month to month. It’s typically calculated in one of two ways: As a percentage of your outstanding balance plus new interest and fees, or as a fixed amount, whichever is greater. For example, say a lender charges either 1% of your balance plus interest or $25. If your balance for a statement period is lower than $25, you’d simply need to pay the entire balance. It’s important to check your statements to understand the policy for your specific card and issuer.

What to consider when paying the minimum

While it may seem like only a small thing, it’s good for you to at least make the minimum payment. Doing so can help you avoid late fees and having your lender report a missed payment to the credit reporting agencies. This is vital to your credit health because on-time payments are one of the important credit score factors.  However, it’s important to understand that the minimum payment is just a small percentage you’re paying goes toward your original or principal balance. This means: 

• Interest charges add up:  Typically, credit companies will charge you high interest rates on unpaid balances.  If you only pay the minimum each month, the interest charges can snowball.  The additional interest and any other fees are added on to your balance and can increase a lot over time.       
• Credit card debt accumulates: Because of this, it can take a while to pay off the debt in its entirety and during that time you’ll continue to pay interest charges. The compounding interest makes the debt grow even faster.  This is how even a modest balance can become quite expensive and take a long time to pay off.

Should I pay off my credit card in full?

If you can, paying the balance in full each statement period is the better option and offers several benefits.  

• Interest-free freedom:  If you pay off the balance in its entirety, you can save some serious money by helping you avoid costly interest payments.          
• Lower debt burden:  Zeroing out your balance each month keeps your overall debt in check.  It can give you peace of mind and free up your funds to achieve other goals like investing in an IRA or saving up for an emergency fun.
• Credit score bump: Paying in full may also help your credit score. In addition to consistently making on-time payments, you’ll be in the good habit of keeping your balances low across your credit card accounts. Your credit utilization, how much of your available credit you’re using, is an important factor in calculating your credit score. In general, the lower your utilization is, the better it is for your score.

Credit utilization

Lets say, for example, you have 2 credit cards.  Credit Card #1 has a balance of $3000 and a limit of $3000.  Credit Card #2 has a balance of $1000 and a limit of $2000.

Your available limit across your credit card accounts is $5,000 and you have combined balances of $4,000, your credit utilization is at 80%.

You’d want to get that down as low as possible — a good benchmark to start is below 30%. For continued healthy credit, it’s best to try to not let balances get too high at any point. When credit card balances grow close to the limit each month, you may see your score fluctuate as well.

If you’ve recently paid a credit card balance down to zero, you should be proud! Know that your reports are not updated immediately with each payment and you may not see a change in your score until the account is reported by your lender, which typically happens once a month.

How much of my credit card should I pay off?

How much of your credit card balances you should pay off will depend on the entire scope of your financial situation. Ideally, you should pay off your balance in full, though paying as much as you can above the minimum will help you save money. But don’t feel defeated even if you’re only able to make the minimum payment each month — you’re still ensuring your credit remains in good standing. Continue to keep track of your payment schedules and credit limit and, when you can, slowly work to pay down that balance. Even if you must chip away at it, you’re establishing a consistent, healthy habit which will serve you well for your long-term financial goals.

Stay on top of your revolving accounts by routinely checking your credit report.  You do so with free weekly copies from annualcreditreport.com.  

(Partially reprinted from www.transunion.com)