When you receive your monthly credit card billing statement, you’ll see a box labelled minimum payment. You’ll also see a number beside it – a lot less than the total bill.
That is the amount you need to stay away from at all costs.
When you use your card, you are not required to pay everything back. You can choose to pay the minimum of the debt – which is just a percentage of what you really owe. This is actually a guide.
The credit card minimum is calculated based on the outstanding balance, fees, and interest rates. You have to pay at least this amount to keep yourself away from defaulting on the credit card debt.
While there is nothing wrong about this minimum amount, your choice to stick to this payment method will eventually put you in danger of accumulating a lot of debt.
What happens if you pay only the minimum?
Before enumerating what happens if you only pay the minimum requirement, how about making certain assumptions?
Assume you have RM10,000 worth of credit card balance. You can also assume your monthly interest rate at 2.75% – this is actually a small estimate as some monthly rates can be between 3% or 4%. Credit cards are quite notorious for their high interest rate.
With these details, assume your initial minimum payment is RM441. If you pay only RM441, you will carry over a balance of RM9,559 to the next billing cycle.
Assuming you no longer use the credit card, the minimum payment requirement will get smaller. If you stick to that amount, it will take you 182 months to completely pay off the debt.
Not only that, it will cost you a total of RM27,438. Since your debt is only RM10,000, you actually paid RM17,438 in interest.
If you did not pay only the minimum but consistently paid RM441 each month, it would have taken you only 36 months to clear the loan.
Apart from that, you would have only paid RM15,880 until the maturity of the debt. Overall, you would have only paid RM5,880 on interest.
If you had paid even more, say RM500 each month, you could have paid off your credit card balance even faster.
Disadvantages of clearing only the credit card minimum
• High debt-to-income ratio. Sticking to the minimum payment will keep your debt level high. As the balance is carried over to the next month, interest, fees, and charges are capitalised into it.
Usually, the interest and charges are based on your balance. If you have a high balance, everything else will be high as well.
• Higher interest paid. As mentioned, your interest will be calculated based on your current balance. If you keep your balance high by paying only the minimum requirement, the interest that will be capitalised into the debt will be high as well.
• Longer term. Since you are just taking nibbles out of your credit card debt, it will take you a very long time to finish paying it off.
• Lower credit score. If your debt-to-income ratio is consistently high, that can affect your credit score.
• More stress. Debt will make you more stressed because of the mounting financial obligations that credit cards bring. Unless you can completely pay off the debt, you will always feel anxious about your financial position.
• Wasted financial opportunities. Imagine the money you wasted paying more than RM17,000 on interest. That could have bought you a relaxing holiday, nice furniture or home appliances.
Tips to pay more than the minimum
While sticking to the minimum will keep you from defaulting on your credit card debt payments, it is not enough to improve your finances.
Here are tips to help you pay more than the minimum requirement.
• Always budget your credit card purchases. You will then have the cash to pay your balance in full when the billing statement comes.
• Try to negotiate your interest rate. If you have a good credit score or you have displayed good payment behaviour, you can negotiate with the creditor to lower your interest rate. This will help lower the minimum payment and get the extra money to pay more than the credit card minimum.
This article first appeared in thenewsavvy.com
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