Understanding Credit Card Minimum Payments

One of the biggest misconceptions when it comes to dealing with credit cards is that by paying credit card minimum payments you are still paying off your debt. While it would be nice to believe that this is true, sadly it is not. It would be a far better plan to create your own minimum payment, one that you can afford, and be one that will actually affect your account balance every month.

When They Say Minimum, They Mean It

It is an unfortunate fact of life that regardless of any promises to the contrary, any credit card issuing agency is out to make a profit. And they make that profit in two distinct ways: membership fees and interest rates. The longer you have a balance on that card, the longer they can make money off of that balance in the form of interest. It is literally in their best interest to make sure that you always have some balance on that card, because every dollar owed makes them a profit to the tune of anywhere from 25% or more in interest accumulated.

In fact, the amount listed on your balance every month for your minimum payment is actually made up of interest, not principle. If you have a balance on that card of say, $2000, your minimum payment, depending on the rate of interest on that card, could potentially be around $40. Out of that $40, $38.22 will be paid towards the interest accrued on your account, while only $1.78 will actually be paid towards the principle of $2000. To create your own "minimum payment" that will actually make a dent in that principle, use the $40 as a base to calculate a higher payment that you can afford to pay every month instead.

Creating Your Own Minimum

The first step is to stop using the card you want to reduce the balance on. The interest is calculated not only monthly but with some cards that have lower interest rates, daily. This way they can get the maximum benefit, even with the lower rate. If you stop increasing your balance, the rate of interest growth will slow, allowing you to actually chop away at the total balance owed with your payment.

The payment you will then make every month will have to be higher than the minimum, significantly higher, otherwise you will just be increasing that dollar and change into only a couple of dollars off the balance every month. A good rule of thumb would be to double the minimum payment, as long as it does not stretch your funds too much. Going back to the example of credit card minimum payments totaling forty dollars a month, if you increase that figure to say sixty or even eighty dollars a month instead, you will reduce your balance by nearly forty dollars, not a dollar and some change. The less you owe month to month, the less they can make in interest profits.