Why Are Minimums Bad

Category: Finance, Credit.

Credit cards are there to put you in debt and keep you in debt. It s called the minimum payment.

When they do it, they have one tool at their disposal that is more effective than all the others. What s a Minimum Payment? If you don t pay your minimum, they ll come after you- but don t make the mistake of thinking its just fine to only ever pay that much. Your minimum payment is the absolute minimum that you must pay off each month to avoid defaulting on the debt. Why are Minimums Bad? Minimum payments used to be set at relatively high percentages, anywhere from 5% to 10% . They never used to be.

This meant that you paid more, but your debt would get paid back faster. This would let them tell people that debts on their cards were affordable , while they raked in the cash over the long term, thanks to the power of compound interest. Credit card lenders realized, that they could, though set the minimum payments lower, and collect a smaller amount of money each month for a much longer period of time. Here s an Example. Your minimum payment is 5% per month. Let s say you owed$ 1000 at an interest rate of 17% per year( 1% per month) . Remember that your payment goes towards the interest first, and then the debt.

Well, the difference is enormous. In this example, $10 out of the$ 50 you paid would disappear as interest- but$ 40 would still go towards paying off the debt, meaning that your debt the next month would be$ 96 What happens if you change the minimum payment to only 2% ? Sure, you re only paying an affordable $20- but$ 10 of it is still going on interest. There are so many people who just look at the interest rates they re being charged, and don t understand the terrible difference it can make if you only ever pay the minimum payment. That means that your$ 20 has only paid back$ 10 towards the debt, and you still owe$ 990! In our example( which is relatively typical) , 50% of the payment was going on interest- meaning that paying the minimum gets you an effective 50% interest rate, even though your APR was only 17% .

So What Should You Do? For higher interest rates, it only gets worse: there are cards out there where only making the minimum payments will actually cause you to owe more each month, not less! The answers aren t fun, but they are true. Secondly, always pay more than the minimum if you can afford to. Firstly, look for a card with a high minimum payment- this is a good way to discipline yourself into paying off the debt faster. I know it feels like money for nothing, but isn t it better to pay it now and get it over with, instead of paying it for the rest of your life?

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