Contributing Writer at Tally
November 23, 2021
When you get your credit card statement and see that super-low monthly minimum payment, it may be tempting to pay only that amount so you have more liquid cash on hand.
Giving in to that temptation may not be a wise choice, as it can put you in a financial bind.
We explore how it can affect your financial situation, and we suggest several alternatives to paying the minimum payment that can get you out of debt quicker and potentially save you money.
Yes and no. Let’s explore both scenarios.
Your payment history makes up 35% of your FICO credit score, making it the most important factor on your credit report. As long as you make at least the minimum monthly payment on your credit card bill before it’s 30 days past due, your payment history will remain in good standing at all three credit bureaus: Experian, Equifax and TransUnion.
You also avoid a late fee if you pay at least the minimum amount due by the due date on your credit card statement.
The only negative impact to your score of making just the minimum monthly payment is if you carry a high balance and your overall credit utilization ratio is high. Your credit card utilization ratio is your credit card balances relative to their credit limits — it’s expressed as a percentage.
For example, if you have two credit cards, each with a $500 credit limit, you have a total $1,000 credit limit. If you charge $500 to one of those credit cards, you’d have a 50% credit utilization ratio.
Your credit utilization ratio is part of the “amounts owed” variable in the FICO Score calculation, which accounts for 30% of your credit score. If you continue to make only the minimum monthly payment, your credit utilization ratio will remain high, potentially hurting your credit score.
Credit card companies calculate minimum monthly payments in several ways. Some use a flat percentage of your outstanding balance, like 2% to 4%. That 2% to 4% payment will cover your interest charges first, then the remaining amount will go toward your principal balance.
Other companies add a small percentage of your balance, like 1%, to the interest and fees from the month to come up with your minimum monthly payment.
In both cases, only a small portion of your payment will go toward reducing your balance.
For example, in the first scenario, imagine having a $1,000 balance on a card with a 19% interest rate and a 3% flat minimum payment. Your minimum payment would be $30, and your monthly interest charges would be $15.83. So, $15.83 of that $30 would go straight to interest, and only $14.17 would go toward paying down the balance.
If your credit card issuer uses the percentage-plus-fees method, the result is a little different. Assuming there are no fees, your minimum payment would be $25.83. Of that minimum payment, only $10 would go toward your principal balance, and the remaining $15.83 would go toward interest.
In the flat percentage example, it would take 48 months to pay off your credit card, according to Bankrate’s credit card payoff calculator. Plus, you’d pay out $432 in interest.
In the percentage-plus-fees method, it would take 61 months to repay the debt and cost you $560 in interest.
In both cases, you can see that it will take a long time to pay off your credit card balance and cost you a lot in interest if you’re only making minimum payments.
If you want to reduce the negative impact your high credit card balances have on your credit score or just want to minimize the total interest charges you’ll pay, there are several debt repayment methods that can help.
A debt consolidation loan is a personal loan you use to pay off some or all of your credit cards. Generally, a worthwhile debt consolidation loan has a lower interest rate than your credit cards.
A debt consolidation loan has a fixed term, so you know when you could potentially be debt-free, and you’ll make only one payment to a single lender instead of multiple monthly payments to all your credit cards.
When you pay off all your credit cards with a debt consolidation loan, you will lower your credit utilization. This could result in an increase to your credit score.
The debt avalanche is a tried-and-tested debt-repayment method where you apply all your extra cash every month to the credit card with the highest interest rate while making minimum payments on your other credit cards. Once you pay off the highest-interest debt, you then apply all your extra money each month to the debt with the next-highest interest rate while paying the minimum on your other cards.
Repeat this process until you pay off all your credit card debts.
The debt snowball is another effective debt-repayment method. In this process, you apply all your extra cash every month to the credit card with the lowest balance while paying the minimum payment amount on your other credit cards. Once you pay off the lowest balance, you then apply all your extra money each month to the debt with the next-lowest balance while paying the minimum on your other cards.
Repeat this process until you pay off all your credit card balances.
A personal line of credit is another way to potentially get out of debt. This line of credit will generally have a lower interest rate than your credit cards, allowing you to save money on interest charges.
You can use another credit card to help you beat credit card debt, if you have access to a credit card with a promotional balance transfer APR. In many cases, these promotional APRs are 0% for up to 18 months. Keep in mind that these credit cards usually charge a 3% to 5% balance transfer fee.
Consider the credit card example above with a $1,000 balance at 19% interest with a 3% flat minimum payment. If you transferred the full $1,000, you’d end up with a $1,050 balance due to the 5% balance transfer fee. If the new credit card offered 0% APR for 18 months, you’d be able to pay down $540 of your balance by maintaining the $30 minimum payment you had before the transfer.
You can also divide the credit card balance by the promotional term to calculate what you’d need to pay per month to pay off the entire balance. In this example, you’d be able to pay off your card in 18 months by paying $58.33 per month (1,050 ÷ 18 = 58.33).
Paying the minimum monthly payment is better than making no payment at all, as it maintains your positive payment history. But it can hurt your credit if you carry a high credit utilization ratio, as it prolongs the amount of time you keep that ratio high.
Fortunately, there are ways to drive your credit card balances down, including debt consolidation, the debt avalanche or snowball method, a personal line of credit or even a balance transfer credit card. The key is to choose the method that best suits your personal finance situation and execute it.
You also might want to consider the Tally† credit card debt payoff app. The app can help you manage your credit cards, automate payments, avoid late fees and customize a payoff strategy that has the potential to save you money and get out of debt faster. Tally also offers a lower-interest personal line of credit, allowing you to efficiently pay off higher-interest credit cards.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.