How Do Credit Card Companies Calculate the Minimum Payment?
Every month you carry a balance on your credit card, you have a minimum payment to make. This is the lowest amount you can pay to maintain positive payment history for the month. The minimum payment changes from month to month based on how high your credit card balance is, the interest rate on your card and the fees associated with the card. How do credit cards calculate the minimum payment? Should you pay more than the minimum each month? Check out this helpful guide to learn more about minimum credit card payments.
What Does a Minimum Credit Card Payment Cover?
Your minimum monthly payment serves several purposes. It shows your credit card issuer that you are committed to repaying your debts and keeps your account in good standing. It also pays for a portion of your credit balance, but not as much as you might expect. In most cases, the bulk of a minimum payment goes toward interest. Only a small portion goes toward paying off your principal balance. That is why it is important to pay more than your minimum credit card payment when possible, so more of your money goes toward the principal balance.
Option 1: A Flat Percentage of Your Credit Card Balance
Most credit card issuers charge a fixed percentage of the balance on the card as the minimum monthly payment. If you have a $1,000 balance and a 2% minimum, you will owe at least $20 for the month. Part of that money will go toward interest, and a tiny portion of it will go towards your principal. If your balance the following month was $2,000, you would have a $40 minimum monthly payment.
This percentage is subject to change at any time based on adjustments with your credit card company. You can try to predict what you owe on a regular basis, but it is best to look at your credit card statement just to be sure. If your percentage went from 2% to 4%, you will need to be prepared to pay more money.
Option 2: Pay Just the Interest on the Card
With some credit cards, all you are required to pay for the month is the interest that is on the card. Let’s say your balance is $1,000 and your annual percentage rate (APR) is 12%. Since that is your annual percentage rate, you can assume that approximately 1/12 of it is what you will pay in interest each month. Thus, you would owe 1% of your balance for the month, which would be $10. The higher the APR, the more you will have to pay.
Note that if you are simply paying the interest, you are not doing anything for the balance on your card. You will carry that balance until you start making extra payments. Some credit cards offset that by charging the interest plus 1% of the balance. The extra 1% goes toward your principal. You will still have to pay on the card for a long time to deplete the entire balance, but at least you are taking a step in the right direction.
Option 3: A Combination of Interest, Fees and a Percentage of the Balance
Some credit card issuers calculate minimum payments using several data points – interest, fees, and a percent of the outstanding balance. Past due fees and late payment fees are common, but your credit card may have other fees that contribute to the monthly minimum.
Predicting your minimum credit card payment under this model is a little more complicated. For example, let’s say you have a $1,000 balance and your card charges 1% minimum plus interest and fees. If you have a late fee of $15 and interest for the month of $10, the minimum fee would be $35 (interest + fees + 1% of $1,000).
Option 4: Fixed Minimum Credit Card Payments (“Whichever Is Greater”)
If you read through your credit card terms of conditions, you may see the phrase “whichever is greater” with regards to minimum payments. The credit card issuer sets an absolute minimum payment to make if you carry a balance on the card. If your calculated monthly minimum is below that rate, you’ll pay the fixed monthly minimum. Example: the fixed payment is $25 and your percentage payment would only be $18. You would have to pay $25 because it is greater than your calculated minimum payment. The good news, in this case, is that more money will go toward your principal balance, helping you pay down your debt faster.
Option 5: The Remaining Balance on the Card
If the remaining balance on your credit card is less than any of the monthly minimum payments, you will simply pay off the balance for that month. If you pay more than the remaining balance, the overpayment will go toward a future purchase on the card. You can also request a refund from the credit card company if the overpayment was made in error.
Where to Find Your Minimum Payment on Your Credit Card Bill
Whether you receive a bill online or in the mail, your monthly credit card statement will list your balance summary, minimum payment and payment due date. The balance summary details your previous balance, the new balance you incurred for the month, the previous month’s payment, and any interest/fees you accrued. In the payment section, you should see the total balance you need to pay off and the minimum payment required for the month. There should be information in that section explaining where to send payments to or how to complete your payment online.
On your card statement, you should also see a warning box showing how long it will take to pay off your balance if you only make minimum payments each month. This puts into perspective how important it is to pay more than the minimum. In this sample credit card statement from Discover, a $942 balance would take 3 years to pay off if the cardholder only made monthly payments.
How Does Making Minimum Payments Affect My Credit Score?
Making your monthly minimum payments keeps you in good standing with the credit card company and reflects a positive payment history on your credit report. However, making only the minimum payments may hurt your credit score over time. Your credit score is comprised of several factors:
- Payment History – 35%
- Credit Utilization – 30%
- Length of Credit History – 15%
- New Credit – 10%
- Diversity of Credit – 10%
Your payment history will be positive, but your credit utilization may not be. This is the amount of money you owe versus the amount of credit available to you. If you owe $4,000 and have $10,000 in available credit, your credit utilization is 40%. This value needs to be below 30%. Making minimum payments will not reduce your principal card balance by much since most of that money goes to interest and fees. If you have a high credit utilization rate, you will need to make more than the monthly minimums to boost your credit score.
Should I Pay More Than My Minimum Credit Card Payment?
Just because your credit card issuer calculates a minimum payment does not mean that it is all you should pay. Paying only the minimum each month will drag out your debt and lead to more interest over time. Set your own minimum payment so you can get your balance paid down as quickly as possible.
Try to set a goal for yourself to save or pay a certain amount on your card every week. If you get paid every two weeks, take money out of each paycheck to pay down your balance. Think of these extra payments as a bill with a set due date, not just something that you can pay “whenever.” An extra $50 extra every two weeks will make a huge difference in your credit card balance. That is $1,300 a year! Once your scheduled minimum payment is complete, everything else you pay on your card is going to pay off the balance you owe.
Reasons to Only Pay the Monthly Minimums
There are a few specific scenarios in which paying only the monthly minimum is the right decision. If you owe money on more than one credit card, you may pay the minimum on all but one account. Pay more money on the account with the highest balance or highest interest rate to get your principal balance down. Continue this process each month until the credit card is paid off. Then use the money you were paying toward that credit card to pay off another balance.
If paying more than the minimum would significantly hurt your finances, just make the base payment for the month. For instance, if you recently lost your job or you are on the verge of eviction, your funds are needed elsewhere. You will pay more over time because you only made the minimum payment, but survival is always the first priority. At any point that you feel you will fall behind on your payments, call your card provider and see if you can work out a lower payment schedule.
Feel like you are paying way too much in interest and fees every month? Consider getting a balance transfer card with lower rates. Review all the terms, fees, and charges for the card before choosing the best one for your lifestyle.