What Is Wrong With Minimum Payments
Over the years I have racked up some credit card debt. Not a huge amount, but the purchases have added up and I don’t think I can pay the balance off anytime in the near future. I’m not too stressed about it though because the minimum payments aren’t too high and I have no problem paying it month after month. But a friend called me a fool for handling my credit card in that way. What’s wrong with making only the minimum credit card payments?
Squamish, British Columbia
That’s a great question. Credit cards are many things to many people. A credit card is certainly not inherently evil and if you manage it properly, it can be a great way to build credit and earn rewards.
Where things go wrong is when people spend outside of their means and charge it to their card. A buy-now-pay-later mentality is fine if you have a solid plan for paying off your balance in short order. But if you plan to pay it off slowly over time, you’ll quickly find that this form of financial procrastination will end up costing you.
Spreading your payments out is like running on a financial treadmill. It’ll take a lot of effort but you won’t get anywhere. Maybe the minimum payments are affordable and they fit into your budget. But if you zoom out of your month-to-month life and look at your finances from a more long-term standpoint, you might think twice about that strategy.
Let’s take an imaginary shopping trip. You’ve just moved into a new apartment and you need to furnish it. You’re strapped for cash but you need the furniture now so you decide to use your credit card to spend $5000 on a couch, table, bed, dresser – everything but the kitchen sink.
What happens when you start running on the financial treadmill?
- This is going to take a while – If your credit card has an 18.9% interest rate and your minimum bill is $200 per month, it’s going to take you almost 12 years to pay that off. Hopefully you don’t have pets or toddlers who are intent on damaging your furniture. And let’s also hope you chose a timeless design.
- A meaner kind of inflation – Over the 12-year span of minimum payments, you will have paid 62% more than the original price tag. That $5,000 bill from the furniture shop will blow up to $8,109. And I’m guessing the furniture itself won’t grow in value.
- A moving target – Minimum payments are based on a percentage of your balance, not a fixed amount. This means that the balance owing continues to go down, but at a slower rate-therefore you are in debt longer. A $200 minimum is based on a four per cent payment. After you pay off $2,500, your minimum payment will lower to $100. This stretches out the time that you take to pay the credit card company.
Sorry it’s such a grim picture, Sophia, but it’s one that needs to be painted. Hopefully it will motivate you to take action against your credit card bills. Start by paying just a little bit more than the minimum. Increase that amount whenever you can. And when the minimum payment starts to shrink, don’t fall into the trap – stay on track and continue to increase your payments.
Once your bill is totally paid off, it’ll be like giving yourself a raise each month. The money that would normally be eaten up by bills can go straight into your savings – then you’ll be paying yourself instead of your credit card company.
Jeffrey Schwartz is the Former President of Consolidated Credit Counseling Services of Canada and President of the Credit Association of Greater Toronto (CAGT).
If you have a question about a debt management program or just about finance in general, Jeff is here to help. Send us an email with your question to [email protected]. You’ll get the expert advice you need and your question may be featured here on our website.
What's Wrong With Minimum Payments?
Everything! Don’t fall into the trap of just paying the minimum! Jeff Schwartz President of Consolidated Credit Canada shares his opinion.
I don’t often get easy questions. This is a simple one why? Because everything is wrong with minimum payments. There are only rare situations when it’s a good idea to make the smallest possible payments on your credit cards, and all of them involve just making sure you making a payment. The reality is you always want to pay off your credit cards as soon as possible. In other words, if you have a temporary financial setback and need to make minimum payments for just a little while, that can help you through a rough patch. But other than that, if you make minimum payments, you’ll rack up maximum debt. Here’s an example.
Let’s say you have a $5,000 balance on your credit card. That sounds like a lot, but many Canadians are carrying even more than that.
And let’s say you have an interest rate of 19.9 percent. Again, that sounds steep, but some cards are charging 20 percent these days.
Now let’s suppose your minimum monthly payment is $200 per month. If you make just that payment, and you don’t charge another penny to your credit card, how long do you think it’ll take you to pay off that $5,000?
Is one year? Five years? Or 10 years? Actually, it’s trick question. It’ll take 15 years — and you’ll never guess how much you actually spent.
You’ll have shelled out more than 10,000 to pay off a $5,000 debt. Now do you see why I have a maximum amount of loathing for minimum payments.