What’s the Deal with Minimum Payments in Credit Cards?

In 2021, Value Penguin released some damning statistics about credit card debt in the United States. According to it, over 45 percent of families have this type of debt, and the average amount to be paid is at least $6,000.

And although the percentage of credit card debt against total debt seems to be decreasing through the years, the average credit card debt owed by Americans has been beyond $800 billion since 2017.

Many factors may have caused this massive debt, such as owning more than one credit card. There’s also paying the minimum amount.

Why Paying the Minimum in a Credit Card Is Problematic

Credit cards work like loans in plastic. Every time you swipe them, you’re not only making a purchase but also telling the issuer, such as the bank, that you’re borrowing money. As a debt, you need to pay it.

Now, this is where banks can make money from your account. They can charge you with different fees:

• Late fees every time you miss paying your credit card debt on time
• Additional charges when you’re spending more than your limit (some credit card accounts allow you to do that)
• Annual fees to renew the credit card

However, the biggest source of their revenue is interest, which works similarly to the interest in other loans with a couple of differences.

One, the credit card interest rates are often higher than other types of loans. Currently, the average annual percentage rate (APR) is 20.29. Student credit cards may have a much lower interest rate than business or store, which has the highest.

Nevertheless, regardless of the actual rates, these percentages are still excessive compared to those of mortgage or even auto loans. Car repayments, for example, may have up to 12 percent APR. Someone with a 30-year fixed mortgage, on the other hand, may pay 2.98 APR as the interest.

Why are you paying way more on interest with a credit card? One of the reasons is the level of risk. Unlike other loans, such as mortgages or cars where you can use such assets as collateral, credit cards are usually unsecured. The risks of owners defaulting and the issuers not being able to collect the repayments are high.

But credit card companies know this too. Thus, to encourage you to pay consistently, they give you two options: (1) pay the full balance or (2) settle only the minimum amount.

While paying the minimum gives you some breathing space financially, it is never a wise idea for one reason. The interest is always based on the remaining balance.

To understand this point, pretend that you owe the credit card company $1,000. The minimum payment is only $100, which sounds attractive, so you choose this option.

But since the issuer charges you on the remaining balance, it can take you as long as 10 months to repay this amount, of which almost $70 goes to interest only if we use the average APR of 20.29.

Compare that to adding only $25 each month. This speeds up the repayment to only 8 months, while you give only about $50 on interest.

Therefore, it is not surprising many Americans eventually struggle to pay off their credit card debt within a few months.

How to Pay Off a Big Credit Card Debt

The best way to manage your credit card repayments is to settle the full balance each month. But how can you do it when your money is also tight? You have two options:

1. Get a Personal Loan

If you have a good credit score, you can explore personal loans in the state you’re in. Although they still have a high interest rate, it is usually much lower than that of your credit card. For example, a credit score between 720 and 759 may carry an APR of 12 percent for this type of loan.

Moreover, you can get the money fast (sometimes within 24 hours as long as you have all the requirements ready), and it can have a long payment term.

2. Transfer the Balance of Your Credit Card

Some banks or issuers allow you to transfer the balance of one of your credit cards to another card with a much lower interest rate. This way, you pay less interest on top of the principal. If you can do this within the promo period, you may also not have to pay any fee to balance transfers.

Contrary to what others think, credit cards are not the problem. It’s how you’re using them that could be causing the stress. These include only paying the minimum.

Fortunately, you have at least two options to pay off a huge part of your remaining balance to lower your interest rate in the next months. This will give you enough time to revisit your budget and find ways to pay more money on your card.