What Is a Minimum Interest Charge on a Credit Card?
Don’t let minimum interest charges on credit cards confuse you. Here’s a breakdown of what they are and how to avoid them.
November 18, 2021
Whether you’re a fan of surprises or not, no one likes the surprise of an unexpected charge on their credit card account’s statement balance. Yet many people face this unpleasant discovery in the form of a minimum interest charge. So, what is a minimum interest charge and how can you watch out for them in the future?
To help you understand, we’ll outline:
How monthly finance charges (another term for minimum interest charges) work
Compare them to other credit card charges you might face
Explain how to avoid them
How do minimum interest charges work for credit cards?
As cardholders know all too well, you have to pay significant interest on whatever’s left on your credit card balance at the end of the month (or whenever the cut-off date for paying your balance passes). In addition to paying interest on anything you don’t pay off, using a credit card also means you might incur late payment fees, annual fees and cash advance fees.
But there’s also a charge that often passes unnoticed: the monthly finance charge. The monthly finance charge is a fee that credit card companies include if you didn’t pay your balance in full, but the outstanding balance falls below a certain threshold. In other words, card issuers set a minimum amount they’ll take from you if you fail to ensure your balance is paid in full. It’s sort of like the credit card company rounds up to collect the minimum interest charge.
Sound confusing? Let’s break it down. Say that the interest rate on a credit card is 20%. You had an outstanding bill of $100 at the end of your billing cycle and paid off $99.50.
Twenty percent of $0.50 is negligible, especially when considering the APR advertised applies to how much interest you’ll pay over a year (not a single month). Instead of charging you that $0.05, most credit card issuers set a minimum interest charge.
This way, instead of paying $0.10 or $0.01, you’ll pay the higher minimum interest charge.
While this practice sounds unfair, ultimately, the card terms you agree to detail these charges. It’s another reason why borrowers should try to pay off their full balance if they can.
Bear in mind that some cards come with an introductory rate, which means you won’t have to pay a minimum interest charge (or other fees) for a set period of time.
Introductory rates can confuse cardholders if they get accustomed to carrying over a small balance each month without incurring a monthly finance charge but then get hit with a sudden, mysterious fee after the introductory period ends.
Minimum interest charges vs. minimum payments
It’s also important to highlight the difference between a minimum payment and a minimum interest charge. The terms might sound similar, but they’re very different.
A minimum payment is simply the total amount of your credit card balance you have to pay to avoid the consequences of non-payment. Paying it doesn’t mean you avoid paying interest, so it’s important to pay your balance off in full if you can, but making the minimum payments is the bare minimum you should do.
For instance, you might have to make a minimum payment of $200 each month, regardless of whether your total balance is $250 or $2,500.
If you fail to make a minimum payment, your credit report could take a hit, and you might accrue late fees.
Minimum interest charges can affect you regardless of whether you make your minimum payments but narrowly miss paying off your entire balance or miss your payments but carry a small balance.
Examples of minimum finance charges
Now you know you might face these fees, you’re probably rushing to find out the minimum finance charge for your card. A minimum interest charge between $0.50 and $2.00 can be considered “normal.” Still, if a company is charging anything significantly above that, it might be time to look for a new credit card.
To find out your minimum finance charge, read the User’s Agreement for your credit card. It may be listed as a rounding charge.
For example, this is the rate listed on the Discover website for its cards:
Discover has a $0.50 minimum interest charge across its credit card offerings.
Meanwhile, US Bank has a monthly finance charge of $2 for its Platinum Card:
Minimum interest charges tend to be a small amount of money, so you might think it’s not worth worrying about. But even if the charge is just $1, that’s still $1 a month more than you could or should be paying. To understand how significant they can be, look at the numbers.
Minimum interest charges and annual percentage rate
We need to do a little math to fully understand the difference between paying standard credit card interest and a minimum interest charge.
Credit card interest is calculated as an annual percentage rate (APR), so it’s important to remember that interest is charged on an annual basis. The average APR for U.S. credit cards is 17.13% as of August 2021. Let’s round that up to 20% to make the numbers simpler.
If you carried a balance of $50 in a month, you wouldn’t pay 20% of $50 ($10) in interest. There are 12 months in a year, so you’d pay $10 divided by 12, or $0.83 (the real calculation is slightly more complex, but this is a simplified version). But if your credit card company has a minimum interest charge of $1, you’ll pay $1 in interest rather than $0.83.
So, if you kept up your balance of $50 for the whole year, you’d end up paying $12 ($1 a month for 12 months) in interest instead of $10.
This might sound like a minuscule difference, but $12 is 24% of $50, whereas $10 is just 20%. These seemingly small fees can add up.
How to avoid minimum interest charges
Now you know what a minimum interest charge is, your next question will probably be how to avoid them. Well, cardholders can pay their balance off in full each month to keep from incurring a minimum interest charge.
Make sure you know when the payment due date and grace period are for your credit card. Do your best to pay off your balance before that day comes around.
If you’re struggling, planning ahead by budgeting and using your debit card where possible can help to keep your balance to a minimum.
Also, remember that avoiding charges isn’t the only advantage of paying off your full balance. When you consistently do this, it’ll keep your account in good standing and may improve your credit score, which lenders consider when deciding which interest rates and loan terms to give you in the future. It’s a virtuous circle.
Steer clear of those pesky charges
Being aware of minimum interest charges is the first stage to avoid them and follow good financial practices. If you pay your balance in full each month and keep your credit history healthy, you’ll save money and create a cycle that helps you avoid difficult financial situations in the future.
But don’t stop there. We’ve only skimmed the surface of what there is to know about personal finance management. To keep learning and expand your financial literacy, subscribe to Tally’s newsletter to expand your knowledge.