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On paper, minimum payment for your credit card is a good thing. You just need to pay a small fixed amount or a certain percentage based on total debt, accrued interest, and other fees. Once you’ve settled the minimum amount on your card, then you can continue using it without encountering any problems.
The main purpose of the minimum payment is to allow you to pay a small amount without making you incur late charges – this is especially useful when your budget is tight. Incurring late charges will make your credit score plummet and hurt you in the long run.
While minimum payments are convenient, it’s best not to do it often or think that you can just keep paying the minimum amount to pay off your debt. There are some serious drawbacks to just paying the minimum, especially if you plan to use credit to finance any part of your business.
Longer time to pay
If you only pay the minimum amount each month, the remaining balance will accrue interest. Most of the minimum payment next month will go towards paying the accrued interest rather than paying off the principal.
When you pay more than the minimum, the amount greater than the interest will be applied directly against your principal debt, allowing you to pay off the debt faster.
Paying more in interest
As previously stated, if you only pay the minimum, the remaining balance will accrue interest. The longer this balance remains, then the more interest it will accrue. Remember, interest is applied every month for the remaining balance.
For example (your actual credit card terms may be different), you have charged $1,000 to your credit card with a minimum payment amount of $20 and monthly interest rate of 2%. After paying the $20 minimum payment, the remaining $980 will accrue an interest of 2% or $19.60. If you pay the minimum amount of $20 the next month, this will just be used to pay off the $19.60 interest and the remaining $0.40 will be deducted from the principal of $980 – which will then accrue interest. If this goes on long enough, you’ll find that you are paying more in interest compared to the amount you initially charged – money that you could have used for something else.
Credit Score may be impacted
While having an outstanding debt will not harm your credit score, having a high utilization ratio (total monthly charge vs. credit limit) will affect it. Unless you don’t charge additional debts to your credit card, you may find that your utilization will climb and your credit score will be affected.
When is paying minimum a good idea?
The only time that you should be paying the minimum is when budget is tight and you need to prevent your account from incurring late charges. Minimum payments are a safety net. If you find that you are using it regularly, speak with your credit card issuer and arrange for a repayment plan.
Strive to always pay off as much of your credit card balance as you can. Not only does this prevent your debt from accruing too much interest, it also keeps your credit score healthy.
