When your monthly statement comes, there’s a great temptation to pay only the minimum. Don’t do it. Read your statement carefully for information about how long it would take to pay off your account balance if you only pay the minimum payment. It can take years, even decades, to pay it off. If possible always pay the balance in full every month or pay more than the minimum amount. Doing so will help you to establish an excellent credit rating, a score used by lenders to determine the rate you will pay on your loan.
Just look at what paying only the minimum payment really means:
Example: A credit card with a balance of $1,000 that has an APR of 18%.
| Annual Percentage Rate |
18% APR |
| Outstanding Balance |
$1000 |
| Minimum Payment |
2.5% |
| Years to Pay Off |
13 |
| Total Paid to Credit Card |
$2115.41 |
| Total Paid in Interest |
$1115.41 |
When you break the Annual Percentage Rate (APR) down to twelve monthly periods you end up with a 1.5% finance charge per month. For this example we will also use the assumption that the card calculates the minimum payment by 2.5% of the balance.
This means your minimum payment in the first month is $25, or $1,000 x 2.5%. With the card’s APR of 18% or 1.5% per month that means of that $25 payment only $10 is being applied to the balance while the other $15 is paying that month’s finance charge. During the next month your remaining balance is now $990 so your next minimum payment would be calculated as $24.75 ($990 x 2.5%). For this payment $14.85 covers that month’s finance charge while $9.90 is applied to the balance.
As you can see above, you have made almost $50 in payments yet only reduced your balance by $19.90. If you were to continue paying only the minimum and the features of this card remained unchanged it would take 153 months or almost 13 years to pay off a $1,000 initial balance. This would result in paying $1,115.41 on just interest alone, more than the amount of the original balance.
Follow these guidelines to avoid credit card debt and create good credit at the same time.
- Know your financial means and limits, and don't go beyond them. Only charge items that you know you can pay off each month.
- If you already carry a balance, pay more than the minimum payment (or the most you can afford) to bring down your principal balance. Try to keep your balance as low as possible.
- Shop around before accepting a credit card offer.
- Compare APRs. They range from 7.99% to 30.25%.
- Carry only 1 or 2 major credit cards and avoid using your full credit limit.
- Read the fine print and disclosures.
- If you are making payments on several credit cards, try to consolidate them into a single card with a low APR. Alternatively, you should pay off the card with the highest interest rate first.
Here are some other credit card problems to avoid:
- Balance transfer fees
A 3% charge is not uncommon for transferring the balance on your old credit card to a new one, usually to get a lower interest rate. For every $1,000, it would cost you $30. Transfer $10,000 and you could pay $300. Look for a cap. Even with a cap, you might pay $75 or more. Decide if it's worth it to transfer your funds and pay a fee in order to get a lower rate. If you don't, you might lose money.
- Late payment fees
Late payment fees could run as high as $39. Some cards have a sliding scale, and for any balance over $1,000, you're charged the highest fee.
- Annual fees
They can be as high as $500, often for a rewards program. But many cards promote "No annual fee" to distract you from their other fees. Choose a card with a fee structure that is right for your circumstances.
- Transaction fees
These fees can be up to 5% for cash advances. Want a quick $100 from an ATM? Watch out for a $10 minimum charge. Maximum? Read the agreement. And remember, cash advances usually come at a higher interest rate.
- Over-the-credit limit fee
These can be up to $39. Again, there's often a sliding scale.
- Travel penalty
If you charge purchases outside the United States, your credit card company may add a 1 percent currency exchange fee. Some credit unions and banks tack on an additional 2 percent. Know before you go.
- Why reading the fine print matters.
Penalty fees alone average $113 per year for every American household, but jumps in the interest rate can cost you thousands of dollars over the years.