Editorial Policy

Why Paying Only the Minimum Will Cost You

Eva Norlyk Smith Ph.D.

March 21, 2013

Charging a $2,000 flat-screen high-definition TV to your credit card and paying the comparatively small minimum required payment may seem painless enough. In fact, one of the great conveniences of credit cards is the ability to defer payments on purchases, no questions asked.

However, consistently paying just the minimum is one of the worst things you can do for your long-term financial health.

“Depending on what your interest rate is, it can take years to pay off the debt if you pay only the minimum,” says Joe Ridout, consumer services manager with the consumer advocacy group Consumer Action. “Many credit cards charge interest rates at 20 percent and up. At those rates, it will not just take a very long time to pay off the balance, you will end up paying for the purchase many times over.”

Here's how much paying just the minimum can cost you — and what to do if you think you can afford only the minimum.

Crunching the numbers
The Credit CARD Act of 2009 has made it difficult to ignore how costly it is to pay only the minimum. The Act requires monthly card statements to list how long it would take to pay off the balance and how much interest you would accrue if you pay only the minimum monthly payment.

“For years, this information was hidden, and now it is front and center on the statements, so consumers can make their own decisions,” says Ridout. “That is a huge improvement.”

Paying the minimum is so expensive because, for credit cards with a high interest rate, cardholders essentially end up taking two steps forward, and one step back. The minimum monthly payment is typically at least 1 percent the balance owed, plus any interest charges. So, say your APR is 18 percent and you pay only the minimum. You'd end up paying 2.5 percent of the total balance at the bottom of your bill (1 percent of the balance plus the 1.5 percent monthly interest charges that come from your 18 percent APR). However, interest charges would add another 1.5 percent to your balance the next month.

To see how this plays out, consider a person who owes $8,000 on a credit card with a 22.99 percent APR. By paying a fixed monthly payment of $200 per month, it would take about six years and five months, and about $7,300 in interest, to pay off the debt. Not great, but at least the person would be out of debt.

Now let's say the same person pays only the minimum payment each month. This will start out at around $200, but will then decrease as the credit card balance is reduced.

Want to venture a guess at how long it will take to pay off the debt? Paying only the minimum monthly payment each month, it would take a whopping 23 years and just over $14,000 in interest charges to pay off the exact same balance.

Paying the minimum can cost you in other ways as well. Keeping high credit card balances (more than 30 percent of the credit limit) for extended periods of time will increase your credit utilization, a measure of how much debt you carry in relation to the credit available. Credit utilization accounts for 30 percent of your FICO score. So, next to failing to pay bills on time, carrying high credit card balances is one of the worst things you can do for your credit score.

Tips for paying down debt faster
Credit card statements also list how much you would have to pay each month to pay off the balance in three years, another requirement introduced by the CARD Act. This makes it easy to determine how much to pay to erase credit card balances within a reasonable span of time.

But what if you just don't have the money? Most people don't choose to pay only the minimum payment. They do so because they have no other option. If this sounds like you, here are four tips to help you pay down that debt faster.

1. Determine the source of the issue. If you have a large credit card balance and are unable to pay more than the minimum payment, it's important to ask how this came about in the first place, Ridout says. How much of your debt was due to overspending? How much was due to circumstances you couldn't control, like a medical emergency? Determining the source of the problem is key to avoiding it in the future.

2. Follow the money. Many people get to the end of the month and have no idea where all the money went. If that sounds like you, spend a month or two tracking your expenses on a daily basis. Use free online tools, such as these free Google Docs templates or mobile phone apps [link to your blog] for tracking expenses and paying off your debt. Knowing where the money goes makes it easier to see where you can cut back.

3. Fix the leaks. Resolving financial issues involves some combination of cutting back on spending or increasing income. Increasing income isn't always possible, so for most, the best strategy is to determine where you're spending money that could otherwise be used for debt payments.

“If you are only making minimum payments on a large credit card balance, you almost surely have some leaks in the budget,” Ridout says. “So you have to find those leaks and fix them. It can be as simple as a large cable TV bill that needs to be scaled back, a large car loan that you might be able to refinance at a lower rate, and so on.”

4. Be patient. You won't get rid of debt overnight, but increasing monthly payments consistently over time will pay off big time at the end. In the example of the $8,000 card debt above, if the monthly payment increased from $200 to $400, it would cut the time needed to pay off the debt by more than four years (to two years and two months). During that time, interest charges accrued would be $2,173 — less than a third of the roughly $7,200 paid with $200 in monthly bill payments.

Can't swing $400? Bump up your monthly payment by just $50 (to $250), and you'll still save about $2,700.

Savings like that might be motivation enough to forego some short-term pleasures and attack your debt.