How are Minimum Credit Card Payments Calculated

So you have a few credit cards and you work to pay the bills diligently every month, even though sometimes money gets tight, but do you really know what you’re paying? Often as consumers, we get complacent just paying bills as they come in without actually thinking about what this money is really covering. So how does the credit card company calculate how you pay them back?

In some cases, the minimum payment required each month is calculated by taking a small percentage of the total debt owed on your credit card. Typically this is between 2% and 5%, and you can usually find the calculation value listed on your credit card statement. In other cases, the credit card company uses a formula that takes 1% of your total debt plus the interest accrued for that month.

The real trouble for consumers with either of these payment calculation options is they maximize the amount of time you stay in debt. This means you take longer to pay your debts back. In turn, this gives your debt more time to build interest with each month that passes. Considering the APR on your credit card is probably higher than 15%, your credit cards really have a monthly interest rate of at least 1.5%. This means most of what you pay each month is only used to cover the interest accrued in that particular month. The principal (the original amount owed on the debt) only decreases by a few dollars.

Let’s say you spend $1,000 on a credit card with 15% APR and a minimum payment calculation of 2% of your total debt. Your first payment will be $20, but only $7.50 of that sum is used to pay off the principal; the remaining $12.50 covers the interest accrued. This means next month when your bill is calculated, the credit card company takes 2% of $992.50; now, you pay $19.85 and only $7.44 of that goes to paying off the principal. This continues, until you get to the minimum payment limit, which is usually $15. Once that happens you’re usually paying less than $5 each month to paying off your actual debt. As a result your $1,000 debt takes over nine and a half years to pay off and you pay over $850 in interest.

This is where you can see the real profit for the credit card company. They extended you a line of credit to purchase the $1,000 item when you wanted it, but they end up making almost as much as the purchase price of that item after the interest is applied to your credit card bill. This maximizes their profits and how much you’ll end up spending. It’s not a scam—it’s just the way credit cards work.

This is why it’s essential in a good money management strategy to pay more than the minimum amounts due on your credit card bills. Consider in the example above, if you can simply commit to paying $20 every month, instead of just on your first bill, you can actually pay off the same debt in about six and a half years and would pay less than $580 in interest. You drastically reduce the interest paid and the time it takes to repay the debt simply by fixing your first minimum payment amount. Pay an extra $10 each month and you can have the debt paid off in just 44 months with only $301 paid in interest.

If you want to get onto a fixed payment schedule, but you don’t think you have enough money in your budget to commit to a fixed payment schedule, consider contacting a nonprofit credit counseling agency. Nonprofit agencies often offer free debt and budget consultations, which allow you to have an expert assess your debts without adding another bill for you to pay. A certified credit counselor can help you identify places in your budget where you may be able to reduce spending, as well as offer options for debt relief if you need some help getting back on track.

Connie Solidad has been writing about finances and debt consolidation for years. She’s an expert in the industry and writes about management of personal debt, loans for debt consolidation and credit counseling options and resources. When Connie is not working, she loves playing with her two dogs in Tampa, Florida. To learn more about debt management refer to ConsolidatedCredit.org. 

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1 comment to How are Minimum Credit Card Payments Calculated

  • […] Lets say you spend $1,000 on a credit card with 15% APR and a minimum payment calculation of 2% of your total debt. Your first payment will be $20, but only $7.50 of that sum is used to pay off the principal; the remaining $12.50 covers the interest accrued. This means next month when your bill is calculated, the credit card company takes 2% of $992.50; now, you pay $19.85 and only $7.44 of that goes to paying off the principal. This continues, until you get to the minimum payment limit, which is usually $15. Once that happens youre usually paying less than $5 each month to paying off your actual debt. As a result your $1,000 debt takes over nine and a half years to pay off and you pay over $850 in interest.Source: thehowtogetoutofdebtplan.com […]

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