Let’s address the following timely question: “How are credit card minimum payments calculated?”
Since the credit crunch hit, credit card minimum payment requirements have been going up as card issuers attempt to tighten their grip on borrowers’ spending habits.
Instead of letting them run up hefty credit card balances, they’re requiring card holders to pay down balances more quickly to limit their liability.
These changes seem to be targeting those with large balances who have done little to pay them down over the years (see Chase raises minimum payments on credit cards).
Especially those with balance transfers that pay nothing more than the minimum payment.
So how does it work? Like all questions related to credit cards, it depends on the card issuer, as they all set different rules.
One general rule you can count on is that issuers will use a certain percentage of your outstanding credit card balance, such as one or two percent, as the minimum payment.
So let’s look at an example:
Outstanding balance: $2,000
Minimum payment: 2% of balance
If we take the 15% APR and divide it by 12 months, we get 1.25%, or $25 of $2,000, but we’ve still fallen short of the minimum payment requirement of two percent.
So you tack on the remaining 0.75%, or $15, making the minimum payment $40 in this example.
If we break down that $40 minimum payment, $25 is going towards finance charges, or interest, while the remaining $15 goes towards the principal balance, or what was actually spent on purchases.
As you can see, making just the minimum payment is a losing proposition, as it’s mainly credit card interest that is paid each month, while the overall credit card balance drops marginally.
If the finance charges happen to be more than the 2% minimum, some card issuers may ask you to pay all the monthly finance charges plus a certain fixed amount on top of that, such as $15, so some of the principal is actually paid off.
Card issuers also typically have a minimum amount that must be paid regardless of the size of your balance, such as $15, assuming your balance is too low.
For example, 2% of a $500 balance is only $10, so you’d need to pay an extra $5 to meet that minimum payment requirement with some issuers.
For 0% APR credit cards, there is a similar minimum payment that must be paid, as no interest is due.
Typically, any one-off fees, such as over-the-limit and late fees must also be paid as part of the minimum payment.
Contact your individual card issuer to inquire about how credit card minimum payments are calculated, as they vary and may change from time to time.
Keep in mind that if you only make the credit card’s minimum payment each month, you’ll pay a lot more in interest and it’ll take a lot longer to pay down balances.
It’s recommended that you pay more than the minimum each month to avoid unnecessary finance charges (how to pay off credit card debt?).
And while some may complain about card issuers raising minimum payment requirements, it’s actually a benefit to customers because it means less interest in the long run.
But for those just scraping by, it’s obviously not a welcome change.