Imagine having a whopping $10,000 in credit card debt, but only having to pay $200 a month. The $200 is the beautiful songs of the Sirens. The $10,000, and the interest you’ll pay by making just the required payment, represent the rocky island. Here’s how to avoid disaster.
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How To Calculate Your Minimum Card Payment
Credit card companies require you to pay a very small percentage of your total balance each month. While the amount varies from one company to the next, 2 percent of the outstanding balance or $15, whichever is greater, is common. To calculate your monthly payment, simply multiply your total balance by the percentage your particular credit card requires you to pay each month.
For example, if your balance is $10,000 and your credit card company requires you to pay 2 percent of that total, your monthly payment will be $200 (10,000 x .02= 200). You can use this handy calculator from Bankrate as well.
Why Making the Minimum Payment Costs A Fortune
So $200 per month on a balance that large seems like a gift. Think again. Most credit cards charge an interest rate of 15-18 percent each month. The minimum payment includes any interest you owe. As a result, any outstanding interest is deducted from your minimum payment first. What’s left then goes to reduce your balance.
For example, if there is 15 percent interest on the $10,000 balance, $125 of the $200 payment goes to interest (15% / 12 * $10,000). Only the remaining $75 is deducted from the balance. At this rate, it would take over 35 years (424 months) to pay off the balance. And you’d end up actually paying more in interest ($15,281) than what you charged to the card in the first place. Your $10,000 balance will end up costing $25,851. The only one receiving a gift from making your minimum payment is your credit card company.
The table below is a snap shot of what it would look like if you paid only the minimum payment for just the first two years.
Credit Card Statements to the Rescue
Thanks to the new credit card laws over the past few years, card issuers now need to provide minimum payment information in the credit card statement. This information is extremely valuable in understanding the consequences of making just the required payment. You should find two items on your statement: (1) how long it will take to pay off the balance and the interest you’ll pay if you make just the minimum payment, and (2) how much you need to pay each month to pay off your balance in full in three years.
Recently I received a statement for my Citi Platinum Select MasterCard that had a new balance of about $3,000. Guess how long my statement indicates it will take me to pay this balance off if I stick with the minimum payment. 19 years! And the interest costs will total more than $7,000. To pay off the balance in three years I’d need to make monthly payments of $109. This is very useful and eye-opening information, so make sure to find it on your next credit card statement.
Paying A Little Extra Makes A Big Difference
So you’ve resolved that you will shun the Siren songs of the tempting but dangerous “minimum payment.” But you may be thinking that you only have a few extra dollars to put toward your credit card debt each month. The good news is that even a little extra each month will bring down your balance quickly, resulting in less interest.
For example, paying just $50 more per month on your credit card can make a huge difference. Lets say instead of paying the minimum of $200 on the $10,000 balance, you decide to pay $250. You still pay $125 in interest in the first month, but now $125 is being deducted from the original balance. At this rate, you will pay off your balance in just under 5 years (56 months) and end up paying $3,949.66 in interest. That extra $50 a month equals an outrageous savings of $21,901.34 in interest and approximately 30 years of monthly payments. Smart consumer +1, credit card company 0.
This table shows you what your balance will look like after two years when you pay just $50 extra dollars a month.
So the next time you open that statement and think your card company has done you a favor with a low minimum payment, tune out the music and work an affordable extra payment into your budget. Your conscious and your wallet will thank you.