Why You Should Never Ever Only Pay The Minimum Payment
Do you pay only the minimum payment due on your credit card bill? If yes, either change your strategy now or get ready to pay hundreds, if not thousands, more in the long run. We understand that you might find it more tempting to pay the minimum payment and feel financially secured. But this false sense of financial security that ‘your debts are paid each month’ can be extremely expensive.
Experts recommend that you should never ever make only the minimum payment on a credit card. Otherwise, you will eventually end up with a balance so high that you might find it extremely difficult to clear the balance even over several years, maybe even a decade, or more.
Today, we will help you understand why and how paying only the minimum payment can be a risky game for you. Besides, we will also cover what to do if you can’t pay the full amount due. To make things easy for you to understand, let’s start from the basics.
How is the minimum payment calculated?
The calculation of minimum payment varies from bank to bank. Typically, a floor limit is set, which is the lowest minimum payment you are required to pay to avoid late fees, and penalties.
Generally, in the UAE, the minimum amount due is calculated as 5% of your outstanding Credit Card Account balance every month-end.
What happens when I make only the minimum payment on credit card bill?
The concept of minimum payment may look lucrative, but it comes with a catch.
Let’s assume you have a balance of AED 10,000 and the Average Interest Rate on the card is 2.9 % per month – which equates to an Annual Percentage Rate (APR) of 40%.
Based on the 5% minimum payment rate, the minimum amount due would-be AED 500 – which is a much less amount than the balance. When you see it, you feel like you can afford it and decide to make the minimum payment only. As you pay off your debt and the card balance decrease, your minimum payment will continue to decrease, until it hits the minimum payment allowed by the card (which is usually AED 100 in the UAE).
But, what you might not realize is that you are leaving 95% of the debt each month unpaid.
If you keep using your card, the minimum amount will keep increasing each month. Since interest starts compounding on the unpaid balances, when you continue to make only minimum payments on a card regularly, your current balance will start to grow very quickly. Before you know it, you will be left with a debt that is about multiple times the original balance of AED 10,000.
While paying only the minimum amount keeps your credit score intact, overspending or not paying in full for long will leave you with unmanageable debt. When your credit card repayment ratio is not good, it can drop your score eventually.
In your credit card bill, there are generally three amounts you can opt to pay:
- The statement balance – the total balance of your account for that billing cycle
- The current balance – the total amount of your most recent bill along with recent charges (if any)
- The minimum payment due – the smallest amount you have to pay to keep your account in good standing
Ideally, you should pay your statement balance in full each month to avoid high interest charges and debt.
What should I do if I struggle to pay my statement balance in full?
There may be times when you can make only the minimum payment. For those situations, you can pay the minimum – but don’t do it for the long-term. As soon as you have funds available, pay it in full.
If you can’t afford the full balance, you should try to pay more than the minimum to reduce the total amount to be paid and the time required to clear the balance.
However, if you are having trouble paying your balance in full regularly, you need to review your cash flow and spending habits to see where you can cut costs to pay the balance.
Besides, look for a credit card with 0% APR on new purchases or transfer your credit card balance to a new credit card offering no interest for one to two years. Remember, such schemes have time-limits. So, you won’t be able to enjoy these benefits for a lifetime.
Thus, use your credit cards responsibly and prepare yourself to pay balance in the full or at the very least – to pay more than the minimum.