Contributing Writer at Tally
May 29, 2020
The average American household has $5,700 in credit card debt, according to a recent ValuePenguin study. With 78% of American households living paycheck to paycheck, the minimum payments on those credit cards may look enticing. The problem is that only making the minimum payment every month can create a cycle that lasts many years.
Paying the minimum has become such a problem that the Credit CARD Act of 2009 forced credit card companies to warn consumers on their monthly statements that making only the minimum payment will increase interest charges and the amount of time to pay off their debt. The warning must also show the consumer how long it would take to pay off the card if they make only the minimum payment.
You can shorten the amount of time it takes to pay off your credit cards by making payments in excess of the minimum. The exact amount of time it’ll take to pay off your credit card depends on a few variables, including how much you're willing to commit to paying toward your debts and what payoff options you qualify for.
Before we get into the options for paying off your credit card debt quickly, let’s look at how long it’ll take to pay off your credit card by paying just the minimum.
Paying just the minimum payment may feel like you’re saving money, but this has little impact on the actual credit card balance. In fact, when you pay just the minimum, you’re paying more toward interest than the amount you owe, making your payments stretch out over many years. In some situations, making the minimum monthly payments can make the debt last for decades.
Your minimum payment amount varies based on your credit card issuer and how much you owe. Most credit card issuers calculate the minimum payment as a percentage of the amount you owe. There are two main ways they can calculate it:
As a percentage of the total balance plus all interest charges
As a flat percentage of the amount you owe
With the percentage-plus-interest calculation, your minimum payment is a small percentage of the balance — generally 1% — plus your accrued interest charges for the month.
In this scenario, if you have a $2,000 balance at 20% APR and a 1% minimum payment, your monthly minimum payment would be $53.33.
$20 is 1% of your total balance
$33.33 is your accrued interest
With the flat-percentage calculation, your minimum payment is 2% to 4% of the total amount owed.
In this scenario, using the same $2,000 balance at 20% APR with a 3% minimum payment, your monthly minimum payment would be $60.
One exception to these calculations is if you carry a low balance on your credit card. In this instance, a credit card issuer's terms will include a fixed minimum payment of $25-$35. The credit card issuers will only charge this fixed minimum payment if the percentage-based minimum payment is less than the fixed payment.
For example, if you have a $500 balance at 20% APR with a 3% minimum payment, the flat-percentage calculation would be a $15 minimum payment. If the credit card issuer has a $25 minimum payment requirement, it would send you a bill for $25 instead of $15.
While making the minimum payment looks affordable on a monthly basis, it can cost you thousands of dollars over time.
Using the percentage-plus-interest calculation on a $2,000 balance at 20% APR and a 1% minimum payment, it would take you 186 months — that's 15.5 years — to pay off the card. Plus, it would cost you $2,723.45 in interest, according to Bankrate's minimum payment calculator. And that’s if you don't charge anything else on the card for the entire 15.5 years.
The flat-percentage calculation is a little more favorable at 153 months until payoff and $2,110.93 in interest.
You can save money and speed up your time to being debt-free by paying more than just the minimum payment.
Making the minimum payment on your credit card likely doesn't look so attractive now. Fortunately, there are plenty of alternatives that can get you debt-free quicker and easier.
Making additional payments is one of the simpler ways to accelerate your debt payoff. Start by making a budget and cutting down on expenses to free up some extra money to pay toward your credit cards.
With a small financial surplus, you can now start making additional payments.
Using the example mentioned above of a $2,000 credit card balance at 20% APR, and employing the flat-percentage calculation, let’s assume you cut enough from your budget to make an additional $40 per month payment, bringing your total monthly payment to $100.
Just paying that extra $40 per month would pay off that credit card in 25 months and cost you $453 in interest. That’s a savings of 128 months and $1,657.93 in interest charges.
If you have multiple credit cards, it’s easy to get lost figuring out which to pay off first. This is where two debt-payoff methods come into play: the debt avalanche and the debt snowball methods.
With the debt avalanche technique, you make the minimum payments on all your debts while putting all your extra funds toward paying off the debt with the highest interest rate and balance. Once you pay off your highest interest credit card, you take the total monthly payment you were making on that first debt and add it to the minimum payment you were making on the credit card with the next highest interest rate. Repeat that process until you’re debt-free.
For example, imagine you’re trying to pay off three credit cards and each has a $25 minimum monthly payment and the following terms:
Card 1: $250 balance at 21% APR
Card 2: $300 balance at 19% APR
Card 3: $150 balance at 17% APR
If your budget affords you an extra $25 per month to put toward your credit card debt, you would pay a total of $50 per month on Card 1 until it’s paid off. You'll continue making minimum payments on Card 2 and 3 during this time. Once Card 1 is paid off, you’ll pay $75 per month on Card 2 ($50 + $25) until it’s paid off, making minimum payments on Card 3 during this time. Finally, you’d pay $100 per month on Card 3 ($75 + $25) until it’s paid off.
With the debt snowball technique, you focus your extra funds on paying off the credit cards with the lowest balances first. With each credit card you pay off, you combine that entire payment with the minimum payment on the next lowest-balance credit card. Repeat this process until you pay off all your credit cards.
Using the same three credit cards in the above example, the snowball method would have you pay $50 per month on Card 3 until it’s paid off, while paying the minimum balance on Card 1 and 2. You’d then pay $75 per month on Card 1 until it’s paid off. Finally, you’d pay $100 per month on Card 2 until it’s paid off.
While both methods are effective, the debt avalanche saves you the most money on interest charges because it prioritizes the highest-interest credit cards. The debt snowball, on the other hand, keeps you motivated thanks to its small wins early on as you pay off lower-balance cards.
There are several keys to paying off debt, including reducing interest, prioritizing debts and simplifying your finances. Tally uses a line of credit to address all three, helping you pay off your debt far quicker than just making the minimum payment.
The Tally line of credit is revolving, which means you can use it multiple times to pay off several credit card balances, and it comes with a lower interest rate than most credit cards. You use this revolving line of credit to pay off your high-interest credit cards, getting debt-free quicker and with less money put toward interest charges.
Similar to a line of credit, debt consolidation involves using a lower-interest personal loan to pay off high-interest credit cards. When you take out a debt consolidation loan, you use the loan to make large lump-sum payments to your credit cards, rolling the current balances into the loan.
A debt consolidation loan helps in several ways:
Its lower interest rate means less money and time spent getting debt-free.
It eliminates the stress of keeping track of multiple credit card payments by rolling them into one monthly loan payment.
A debt consolidation loan has a fixed payment schedule with a firm payoff date.
However, these are personal loans and often require a good credit score to get approved. If you have blemishes on your credit report or too much debt, you may not be able to get approved.
This will vary greatly depending on the terms you choose and your budget. Generally, debt consolidation loans offer fixed repayment terms of 2-5 years. With terms on the shorter end, your payments will be higher, and the interest rate will be lower. As you increase the length of your loan terms, your payments will be lower, but the interest rate generally gets higher.
The average debt consolidation loan interest rate is 18.56%, as of May 2020. If you took a five-year payment term at that rate to pay off $2,000 in credit card debt, your monthly payment would be just $51.40. If you scaled that down to two years, the payment would jump to $100.39.
It may not be the most orthodox way to pay off your credit cards quickly, but using a balance transfer credit card with a promotional 0% APR rate can help you get debt-free quickly and with minimal extra cost.
A balance transfer credit card often offers a 0% promotional APR for 12-18 months, and you can transfer your high-interest balances onto this credit card and pay off the balances over the course of the promotional period interest-free.
Keep in mind, this service isn’t completely free. There is often a balance transfer fee of 3% to 4%, but that fee is generally far less than you would pay in interest over the promotional term.
For example, if you transferred $2,000 to a 0% balance transfer credit card, you would pay up to an $80 balance transfer fee for up to 18 months of interest-free financing. If you left that balance on a 20% APR credit card and paid only the minimum payment for 18 months, you would pay nearly $600 in interest.
This depends on your financial situation and how much credit card debt you have. Using the $2,000 credit card balance example above and an 18-month 0% promotional APR term, if you made a $115.55 monthly payment on the 0% balance transfer card, you could pay it off within the 18-month promotional period.
If you own a home, you may have access to a home equity line of credit (HELOC). This is a line of credit taken out against the equity in your home — the difference between your mortgage balance and the value of the home — that you can use to pay off high-interest credit card debt.
With the average HELOC rate sitting at 4.98% as of May 2020, you can see how this can save you a lot of cash. Plus, like a debt consolidation loan, a HELOC allows you to roll multiple credit card payments into one monthly payment.
There are a few downsides to a HELOC, though. First, they are tied to your home, so if you default on the loan, the lender could foreclose. Also, like a debt consolidation loan, a HELOC requires a good credit score to get approved.
Like a debt consolidation loan, this depends on the terms the lender offers you.
Generally, a HELOC lender offers you a 20-year repayment term. Stretching your credit card debt over two decades at 4.98% will result in a tiny $13.18 monthly payment, so you may be able to make extra payments and pay it off sooner.
For example, if you pay $100 per month on the HELOC loan, you could be out of debt in just 21 months and save nearly $1,100 in interest charges.
Minimum payments simply don't cut it when you're trying to pay off your credit cards. With credit card interest rates stretching into the 20% and higher range, making the minimum payments can add many years to your debt-payoff plan.
With so many alternatives to falling into the minimum payment model, including a line of credit, debt consolidation or even a 0% APR balance transfer card, there is no reason to spend a decade or longer paying off your debt.
Your credit cards won't wait for you to act, though. The longer you spend making minimum payments, the more that costly interest grows. Get on a firm debt-repayment plan that fits your financial situation today and accelerate toward your debt-free goals.