Paying the minimum payment each month can potentially hurt your credit if it keeps your overall credit utilization high, which has a major impact on your credit score.
You may think paying the minimum on your credit cards every month is good for your credit – it’s not. But how does paying the minimum payment hurt credit? Well, it can impact your credit utilization, which makes up 30% of your credit score. And it’s a potential red flag to lenders.
In this article, we’ll dive into the impact of minimum payments on your credit and overall financial health, detail how to calculate your minimum payment, and explore situations where only paying the minimum might actually be the smart move.
How Do Minimum Payments Impact Your Credit
Minimum payments help to keep your credit card accounts current and in good standing, which may help your credit. But in most cases, paying just the minimum will hurt your credit.
The Positive Effects of Making Minimum Payments
The biggest benefit of making on-time minimum payments, is that over time it can help you build/rebuild credit. This is especially true if you have late payments hanging around on your credit reports. Adding on-time payments is one of the best ways to improve your credit payment history.
Plus, by paying on time each month, you’ll avoid paying late payment fees or penalty APR charges.
The Negative Effects of Making Minimum Payments
While payment history is an important part of your score, so is credit utilization. And by only making minimum payments every month, you’re not decreasing your utilization by much. This can really drag down your score, especially if your cards are close to maxed out.
Credit utilization is calculated as how much of your credit limit you are using. Many experts recommend keeping your utilization at 30% or below. So for a credit card with a $1000 credit limit, the goal would be a balance of $300 or less.
It’s also worth pointing out that when making minimum payments, only part of the payment goes to your balance. The rest goes towards paying the interest.
Not only is making minimum payments bad for your credit utilization, but it can also be a huge red flag to lenders. It indicates to banks and credit unions that you are under financial strain and may be unable to pay back your debts. It will also be a red flag when your landlord checks your credit.
Long-Term Financial Implications of Only Making Minimum Payments
In addition to not being great for your credit, making only minimum payments also hurts your finances. Each month you carry a balance on your credit card, you’ll get hit with interest charges. This can leave you stuck in a cycle where you only seem to be paying off the interest each month and not decreasing your credit card bill.
Over time, these monthly APR charges accumulate. And by the time you pay off the credit card balance, you’ll have paid a significant chunk of change in interest.
In addition to hurting your finances, keeping a balance on your credit cards and only making the minimum payment on a credit card each month can make it harder for you to qualify for other lending products when you need them, i.e., getting a home loan.
How to Calculate Your Credit Card’s Minimum Payment
Each credit card company uses a slightly different minimum payment due calculator. Generally, the minimum payment will be 2% to 4% of your balance plus interest and fees.
For example, using the Forbes minimum payment calculator, a credit card with a $5,000 balance, 18% APR, and a 3% minimum payment would have a minimum payment of $150. And half of that payment is interest. If you only paid the minimum on this card, it would take you more than 16 years to pay it off and would cost you $4,698.46 in interest.
If you’re looking for a reason to pay more than the minimum payment due on your credit statement each month, saving money on interest charges is a good one.
Situations Where Paying the Minimum Might Be Necessary
While you should try to avoid making only minimum payments, especially when your credit card is maxed out, there are a few situations where this can be a useful strategy.
If you lose your job, get hit with high medical bills, or suffer some other sort of financial hardship, paying only the minimum for a few months while you work to get back on your feet is perfectly okay. The important thing is to keep making minimum payments to avoid getting hit with late payment fees.
Another worthwhile use for minimum payments is when you are trying to pay down your debts and improve your credit score. For instance, if you have multiple credit cards, you can focus on paying down just one while paying the minimum balance on the others. Just remember to cascade those payments once that first card is paid off.
Know Your Minimum Payment Rights
To help protect consumers, the Credit Card Accountability Responsibility and Disclosure (CARD) Act requires that credit card companies be transparent.
Each credit card statement must display how long it will take you to pay off your balance when only paying the minimum each month. It must also state how much interest you’ll end up paying based on your current APR.
The act also requires the credit card company to apply any payments over the minimum to your highest APR balance first. Other regulations of the act include caps late payment fees, limits interest rate hikes, and additional protections for younger borrowers.
Ready to Improve Your Credit Health?
So, does paying the minimum payment hurt credit? Yes, it can, especially if your credit utilization is high. It also costs you a lot of money in interest charges long-term and is a huge red flag to lenders. But there are solutions to make your credit score better.
Credit.com can help you on your path towards better credit with personalized guidance and credit insights, by signing up to receive your credit report card.
FAQ
Why Is It More Difficult to Get Out of Debt When Only Paying the Minimum Payment?
Interest is the big reason. Interest charges will make up the majority of your monthly payments. The more you pay in interest each month, the less you pay towards the principal balance, meaning it will take longer to repay your credit card in full.
What Does Minimum Payment Due Mean?
This is the amount you need to pay by the due date to avoid late payment fees and penalties. The minimum payment is calculated based on your outstanding balance and your credit card’s interest rate.
What Are the Benefits of Paying Off the Full Balance of a Credit Card?
The benefits to paying the entire balance of your credit card each month include:
- Building a positive payment history
- Avoiding interest charges
- Keeping your credit utilization low
All of this will help you build good credit, maintain stable finances, and improve your chances of qualifying for new loans and credit cards in the future.
