What Happens If I Only Pay the Minimum on My Credit Card?
What’s in your wallet? If you’re like the average consumer, you’re probably plodding around town with thousands of dollars of credit card debt shackled to your legs. Thanks to high interest rates and easy access, using plastic to borrow from your future is one of the most dangerous forms of debt. But racking up a large credit card bill is only the beginning. The longer you let it follow you, the worse your financial situation becomes.
You may not always see interest trailing your money, but it’s there, lurking with watchful eyes and making its presence felt each month when the bill comes due. The average interest rate on credit cards is in the neighborhood of 15%. If you have poor credit you can expect to pay closer to 20%. Of course, these double-digit rates don’t feel so outrageous if you only pay the minimum each month — the smallest amount of money you can pay without incurring punitive fees or negative marks on your credit history.
While minimum payment amounts vary among different cards, the percentage method is a popular choice of poison. The issuer simply charges a percentage of the monthly balance. For example, if you have a $1,000 balance and a 2% minimum, you will owe at least $20 that month. Minimum payment percentages typically range from 1% to 3%, and you may have a minimum dollar amount. Another way of calculating a minimum payment involves a percentage amount plus any outstanding interest and fees. Either way, it’s best to pay your balance in full every month.
What happens if you only pay the minimum on your credit card? You get charged with making one of the biggest personal finance sins under the heavens. Since only a small portion of the minimum payment goes toward the principal, it can take years and thousands of extra dollars to pay off your original balance. A balance of $3,000 with an interest rate of 15%, and a minimum payment of 2% or $25, will take a little more than 16 years to pay off if you only make the minimum payment each month. You’ll also pay $3,640 in interest charges over that time span, more than the original balance and far more than any cash back rewards you’ll receive.
Carrying a balance can also lower your credit score, which can cost you money in other areas of life. The amount of debt you owe is the second largest component of your FICO credit score. If you’re using a high amount of your available credit, it can lower your score and indicate you are financially overextended. A lower credit score may result in higher interest rates on loans, and may even result in you paying higher monthly premiums for car or home insurance since insurers use information in your credit report to help determine risk.
The best way to use credit cards is to think of them as plastic cash. Only use them on what you can truly afford and pay the balance in full each month. If you think the temptation of overspending is too great, then consider secured credit cards, which are funded with a security deposit but still allow you to build credit as long as the issuer reports the activity to credit bureaus. No one cares as much about your financial future as you do, so take responsibility for it today.
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