How Are Credit Card Minimum Payments Calculated?

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
APR: 15%
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.

Making More than the Minimum Payment on Your Credit Card

When the new credit card rules go into effect on February 22nd (Credit Card Bill of Rights), perhaps one of the most exciting changes will be the way payments are allocated.

In the past, credit card issuers applied payments over the minimum payment to balances with the lowest APR because it worked in their favor.

Let’s look at an example:

Total credit card balance: $5,000
Purchase balance: $3,000 @ 18% APR
Balance transfer balance: $1,500 @ 0% APR
Cash advance balance: $500 @ 20% APR

In the scenario above, credit card issuers would apply any extra payments to the balance transfer balance set at 0% APR.

That would leave the balances subject to the highest APR and their associated finance charges untouched, effectively costing cardholders more money.

It wouldn’t be until that $1,500 balance transfer balance was paid off before the purchase balance and finally the cash advance balance would be paid down.

The shady practice meant big money for credit card issuers, and never-ending debt for struggling cardholders.

Fortunately, lawmakers said enough was enough, and stamped out the so-called negative payment hierarchy business once and for all.

Payments Beyond the Minimum Attack Highest APR Debt First

Going forward, the reverse will be true when you make more than the minimum payment.

So in the example above, any extra payment(s) will attack the cash advance balance first because it has the highest APR, and thus the costliest finance charges.

The last balance to be paid down will be the balance transfer amount set at 0% APR, which benefits cardholders because it’s not accruing any interest whatsoever (at least during the promotional period).

The rule change is good news for credit cardholders looking to pay down debt; of course, it should have always been this way, but better late than never.

Just note that those still only paying the minimum payment will continue to see their high-APR balances paid last, so it’s now more important than ever to pay a little bit extra each month.

Read more: Should you pay your credit card in full each month?

What Is an Excellent Credit Score?

For those obsessed with their credit score, I’ll attempt to answer the age old question, “What is an excellent credit score?”

For the record, we’re talking about FICO scores, which are far and away the most common and widely used by creditors.

The FICO score ranges from 300-850, with higher scores representing a lower risk of default.

In other words, higher scores are what you want to shoot for if you want to get approved for everything you apply for and receive the best terms.

Before I begin, let’s remember that the word excellent is highly subjective, and not any specific measure of creditworthiness.

In fact, all of credit scoring is subjective; creditors don’t just look at the three-digit number and say okay, you’re good. Or you’re bad…

However, there are certain thresholds that are objective, meaning lenders will reward/partially approve you for being at or over a certain number, and vice versa.

Excellent Credit Score = Easy Approvals and Best Terms

All that said, an excellent credit score is generally one that will allow you to qualify for most any loan or credit card with the lowest interest rate.

Obviously having an excellent credit score can save you a ton of money on everything from your car insurance to your auto lease to your mortgage.  Over the years, the savings could enter the five to six-digit range.  Seriously.  That’s why financial experts always stress the importance of credit score health.

It’s the one thing you have full control over, unlike income, employment, assets, and so forth.

If I’m forced to throw out a number, which I believe I am, I would say 760 is an “excellent credit score.”

Why 760?  Well, from my experience in the credit industry, I’ve seen pricing adjustments and credit score requirements across the board.

But I’ve never seen any lender ask for anything more than a 760 credit score , and I’ve never seen anything extra offered to those with credit scores beyond 760.

Even FICO constantly highlights 760 as the excellent marker. Check out this recent graphic from their blog, which reveals that very few younger consumers have excellent credit scores, compared to older generations.

excellent credit scores

In recent years, younger consumers have been increasing their share of excellent scores, likely because they were able to sidestep the housing bust, while older folk got tangled up in it and saw their scores fall from grace.

When it comes down to it, most consumers who have 720 credit scores are usually golden, meaning credit score alone won’t hold them back from credit approval, and it may not even lead to a higher interest rate.

But it’s hard to call a 720 credit score excellent, especially since the average credit score hovers around that number. And excellent and average are certainly not synonymous.

So there you have it, are you excellent?

Keep in mind that even if you are excellent, you may not get approved for that credit card or loan you have your eye on, while your average friend just might because credit scoring is just one piece of the pie.

I explain this in greater detail in my good credit score article, which focuses on the importance of credit history and depth of credit.

In summary, you clearly don’t need to be perfect to remain excellent in the eyes of prospective creditors.

And as alluded to earlier, there isn’t much of a benefit between 760 and 850 credit scores, so there’s no reason to think you’re missing out on anything if your score falls between those numbers.

Just keep focusing on healthy credit scoring habits and you’ll be just fine.

Interestingly, Capital One defines excellent credit (generally) as someone who has never declared bankruptcy or defaulted on a loan.  And hasn’t been more than 60 days late on a credit card, medical bill, or loan in the past year.  And someone who has had a loan or credit card for at least three years with a credit limit of $5,000 or higher.

In other words, the score itself isn’t enough to be excellent. You also need to have a certain credit history, which includes supporting sizable amounts of debt without slipping up. Of course, another company may define it completely differently.

Which Credit Score Do Lenders Use?

We all know it can be tough to achieve and maintain a healthy credit score, but the task becomes much more difficult knowing that there are numerous credit scores out there.

For simplicity sake, there are three main credit scores offered by each of the 3 major credit bureaus, including Equifax, Experian, and TransUnion.

These credit scores can range greatly, depending on what information each bureau has compiled about you.

For instance, Equifax may know that you were late on a credit card payment two months ago, while TransUnion may have failed to report the derogatory account entirely.

(Why credit scores are different.)

As a result, your credit score with Equifax could be 675, while your credit score over at TransUnion could still be a rather excellent 750.

Which Credit Score Do They Use?

So, “which credit score do lenders use” anyways?  Well, the answer to this common question can vary considerably, and for that reason, you need to stay on top of credit so you’re golden no matter what credit score is used.

Generally, a prospective creditor will only pull a single credit score from one of the major bureaus mentioned above. After all, it’s cheaper to pull just one credit score as opposed to two or three, and they usually rely on one company of their choice.

Unfortunately, knowing which one they’re going to use is a bit of a mystery.  For this reason, it’s imperative that you’re in good standing with each credit bureau to avoid any uncertainty.

Also keep in mind that your credit scores will probably be slightly different than what you may see if you order a consumer credit report or free credit score on your own, or if you use a service such as Credit Sesame or Credit Karma.

While the numbers may not be far off, it’s important to understand that there will typically be some variation, so don’t be surprised if the lender’s credit report differs from yours.

So if there are three credit scores on my credit report, which one do the lenders use?

If you apply for a mortgage, a certain credit scoring formula not available to the public may be used by the issuing bank or lender. On top of that, mortgage lenders rely on tri-merge credit reports, which contain all three of the major credit scores.

And because they can’t use all three, they take the middle score. So if you’ve got a 750, 680, and 660 credit score, they would use the 680 credit score, which is a below average credit score. Again, this illustrates the importance of having a good credit score, no matter which company is being used.

If you only have two credit scores, which can happen from time to time on a light credit file, the lender will use the lower of the two credit scores.

This is why it’s important to ensure your information is accurate and up-to-date with all the credit bureaus, as you won’t know who a certain bank or lender may choose to run your credit with.

Remember, if you practice healthy credit habits, like making on-time payments and keeping balances low, it won’t matter which credit score lenders use, so don’t fret.

Read more: How to raise your credit score.

Does a Credit Check Lower Your Credit Score?

Consumers often wonder if it’s harmful to have your credit report or credit scores pulled.

So, “does a credit check lower your credit score?”

Well, like all things in the credit score realm, it depends.  Sigh…

There are a number of different reasons to run a credit check, and thus the confusion.

Checking Your Own Credit Will Not Lower Your Credit Score!

Let’s knock out the easy ones first.  If you’re simply checking your own credit via a free credit score website or via the FTC’s free credit report program, your credit score will not be affected in any way.  This means it won’t go up or down.

These consumer credit reports (and scores) allow you to see what’s up with your credit history, but pose no harm to you because you’re not actually seeking new credit, at least not right then and there.

Think about it; why would you be penalized just for checking your own credit report and/or score(s)?  That wouldn’t make any sense. If anything, you should be commended for keeping an attentive eye on your credit history.

Related to that, you have a right to order a free credit report every 12 months from each of the three major credit bureaus (get a free credit report without a credit card).

When you order one of these free credit reports, it actually breaks up your credit inquiries into two separate buckets.

Inquiries Shared With Others

These inquiries are the ones that you initiated, typically in order to get some kind of credit, such as a credit card, auto loan/lease, mortgage, cell phone, etc.  They appear on your credit report and are visible to other prospective creditors and employers if and when they pull your credit report.

Put simply, they’re visible because they affect your credit in one way or another. And creditors need to see them to make subsequent lending decisions.

Inquiries Shared Only With You

The other section you’ll see is the inquiries that do not hurt your credit, and are visible for you only as a record of activities.

For example, if you sign up for Credit Karma or Credit Sesame, which are free credit score providers, inquiries will show up on your credit report each month but won’t count against you in any way. You may also see credit inquiries from insurance companies if you got a few quotes recently.  Again, these do not affect your credit score because they do not involve credit of any kind.

Any pre-approved offers you qualify will also be soft inquiries, meaning they don’t count against you.  And occasional check-ups from existing creditors also fall into this category, as do background checks from employers.

It should even say explicitly on the credit report that “the following inquiries do not affect your credit score.”  They’re just there to let you know that a company is actively pulling your records.

Other Considerations

Now suppose you already have a credit card open with a company and they want to keep tabs on you. If they do a credit check just to see how things are going in your life, it won’t lower your credit score. Why?  Because you didn’t initiate the request and you’re not actively looking for new credit.  They’re simply checking up on you.

The same is true of companies researching your credit profile and subsequently sending you so-called pre-approved or pre-screened offers; it won’t hurt your credit score.

In all these instances, you did nothing to prompt the credit check, so you won’t be penalized in any way.

Similarly, if you apply for a job and your potential employer orders a credit report, it won’t lower your credit score because no new credit is at stake. They simply want to check out your financial background, so again, it won’t affect your credit score.

These types of inquiries do NOT hurt your credit score:

[crosslist]

  • Requests made by YOU for your credit report and/or credit scores
  • Promotional inquiries made by lenders and credit card issuers to send pre-approved offers
  • Credit checks initiated by insurance companies
  • Credit pulls from prospective employers to check your background
  • Existing account reviews (credit card issuers check up on us from time to time)

[/crosslist]

The only time your credit score could drop as a result of a credit check is when you apply for new credit.

Examples include applying for any type of loan, such as a mortgage, auto loan, auto lease, a new credit card, or an increased credit line with an existing card or loan.

These are the only instances when a credit check will lower your credit score, as new credit or inquiries for new credit pose new risks, regardless of how great of a borrower you’ve proven to be in the past.

In the eyes of creditors, consumers who are actively seeking new credit pose a greater risk of default.

Of course, the stronger your credit profile, the less impact these, dare I say, harmful credit checks will have on your credit score.

As a rule of thumb, the more hard credit inquiries you have in a short period of time, the more your score will drop, so exercise moderation.

Chase Balance Transfer Fees Climbing to Five Percent

Chase has begun to raise credit card balance transfer fees to as much as five percent on some of its credit cards, according to Bloomberg.

The move is the result of increased regulations and supposed costs related to new credit card rules recently signed by President Obama, set to go into effect in August.

Among the changes are the abolishment of universal default and negative payment hierarchy.

At that time, Chase will make a number of changes, including raising the fee for cash advances and making some fixed rate credit cards variable, likely anticipating a rise in the prime rate as the economy begins to repair itself.

The five percent balance transfer fee will be the highest in the industry, beating out Bank of America’s four percent fee, which was imposed in June to reflect higher costs.

Of course some card issuers, including Chase, don’t have ceilings on balance transfer fees, so a lower percentage with no ceiling could turn out to be more expensive than a higher set percentage.

For example, if you transfer a balance of $7,500 on a credit card with a three percent balance transfer fee and no ceiling, the cost would be $225.

Conversely, a balance transfer fee of five percent with a ceiling of $150 would limit your fees on a high balance transfer.

Unfortunately, many credit card issuers have eliminated balance transfer fee ceilings, so fees will likely be higher industry-wide (Check out existing no fee balance transfer credit cards).

Back in February, Chase raised minimum payments amounts and imposed a monthly service fee for cardholders who carry large balances without paying them off.

That fee was subsequently returned to most Chase customers after New York Attorney General Andrew Cuomo argued that the standard balance transfer fee should be the only fee related to the accounts.

Look for all the credit card issuers to become increasingly harsh as the new rules are implemented later this summer.

What Credit Score Do You Need to Get a Credit Card?

A frequently asked question in the consumer credit realm tends to be, “what credit score do you need to get a credit card?”

Unfortunately, the answer to this question isn’t one simple three-digit number, but rather a variable answer dependent on a number of factors.

Though a numerical credit score is used in the decisioning process, what’s behind that credit score matters too.

Approval Goes Beyond Your Credit Score

Let’s put it this way; you could have a higher credit score than another individual, but subsequently be denied for the exact same credit card that the other person gets approved for.

How would that work, you ask?  Well, in one common scenario, you could have a better credit score than another applicant, but too many recent credit inquiries or newly opened accounts, likely other credit cards.

As a result, a credit card issuer may deny your credit card application while simultaneously approving an application for a consumer with a lower credit score. That other consumer may have had a late payment at some point in their credit history, but no recent requests for new credit until said credit card application.

So in the eyes of the credit card issuer they are deemed less of a default risk going forward, despite some missteps in the past.

Meanwhile, because you opened so many new accounts recently, you’ve presented yourself as a bit of an unknown risk, at least over the short term, so a credit card issuer may deny you.

That’s just one example, but the main take away is that credit card issuers may take a hard look at your credit score, instead of just saying all credit scores above “X” number get approved, and all credit scores below “Y” number will be declined.

At the same time, it’s generally safe to say you’ll be approved for most credit cards if your credit score is above 700 (assuming you don’t apply for too much credit all at once), as it’s considered a good credit score.

But you may need a credit score of 720 or higher to qualify for certain platinum cards or other rewards credit cards that require so-called excellent credit (what is considered an excellent credit score?).

[Check your credit score before applying for a credit card!]

Minimum Credit Score Needed for a Credit Card

If you’re credit score is below 620, or even 640, there’s a good chance you WILL NOT be approved for most credit cards, though you may be able to get your hands on a credit card for “poor” or “fair” credit. Unfortunately, a lot of the most desirable credit cards are not in those two categories.

If your credit score falls between 620 and 700, it’s a bit of a crap-shoot as to whether you’ll be approved for a certain credit card. If you look at credit card offers on Credit Karma, you’ll notice the average credit score and minimum credit score needed for approval. This should give you a better indication of what it takes to get approved for a given credit card.

Approval can also be determined by the credit card issuer’s risk appetite, which has certainly become less favorable for consumers in light of the ongoing credit crisis.  They’re definitely taking a harder look at applicants than they were in the past.

Also note that credit score and credit history are just one piece of the pie.  Approval is also based on your income and employment, so don’t assume you’re golden just because you’ve got an 800 credit score.  You might be in for a rude awakening.

Tip: Credit scores are also used to set your credit card limits, so the higher your credit score, the higher your limit, generally. Again, income/employment will also come into play.

Cut Credit Lines Don’t Really Lower Credit Scores

Cut credit lines aren’t impacting credit scores as much as some seem to think, according to a study by FICO.

The creator of the FICO score, which studied credit scores between April and October of 2008, found that 16 percent of U.S. consumers experienced a reduction in revolving credit during that time.

Of those consumers, 11 percent had no “risk trigger,” defined as a late payment, collection, or public record, while the remaining five percent did experience some kind of adverse event.

FICO found that in many cases card issuers cut credit limits unrelated to risk, such as to free up capital for use in other lending products and/or to meet regulatory requirements.

Those with no risk trigger typically had their credit lines cut as a result of inactive or low-balance credit card accounts, doing little to impact most consumers’ credit utilization rates.

In fact, lenders only cut an average of $2,200, representing approximately five percent of the average total revolving credit line for these consumers.

“For borrowers in the no-risk-triggers segment who received a reduction in total revolving credit, the median FICO score actually increased from 768 in April to 770 in October 2008,” FICO said in its report.

“Contributing to this positive score change were lender updates to their credit reports which reflected good credit habits such as paying bills on time, paying down revolving debt, and taking on new credit sparingly.”

“For the smaller population of people with recent negative triggers on their credit reports, their scores tended to drop at least slightly in response to the lenders’ actions, their own delinquent repayments, and other changes on their credit reports.”

So there you have it; if you continue to pay bills on time, keep balances low, and apply for new credit sparingly, you shouldn’t see any major credit score dings, even if a credit card issuer decides to slash your limit.

(photo: neubie)

20 Million Credit Cards Were Closed Last Month

If you’re curious how bad it’s getting in the credit card world, a new report from credit bureau Equifax might be a pretty clear wake up call.

Last month, banks closed a whopping 20 million credit card accounts, according to data from Equifax obtained exclusively by Reuters.

The total number of credit cards has now fallen by 58 million from a July 2008 peak of 380 million cards, wreaking havoc on small businesses and consumers who rely upon credit.

Additionally, credit limits have slid by $425 billion from a July peak of $3.59 trillion to $3.16 trillion as of last month.

Meanwhile, card issuers are putting the brakes on new card applications, with the number of new bank cards issued in January and February off 38 percent from a year ago.

It’s no mystery why; last month, 4.7 percent of payments on bank-issued credit cards were at least 60 days behind, an increase of nearly 40 percent from the same period last year.

The good news is that those who continue to make on-time payments and keep balances low should be unaffected by the ongoing credit crunch.

Most of those seeing their credit card limits cut carry hefty balances without paying them down significantly, while many others have had their accounts closed simply due to inactivity.

If you have a credit card that you rarely use, but want to keep open for the credit score benefits, consider using it to pay a recurring monthly bill with automatic payments.

(photo: smith)

Is ID Required for a Credit Card Purchase?

Credit card Q&A: “Is ID required for a credit card purchase?”

Credit card rules are often gray, what with the fact that multiple companies are operating in the same space.

Then you’ve got the merchants’ own rules, which sometimes don’t coincide with the terms of Visa, MasterCard, or American Express, whether they are contractually acceptable or not.

That brings us to a common question regarding identification and credit cards.  Some merchants may ask for ID when you attempt to make a purchase with your credit card, though according to Visa, it’s not a “condition of acceptance.”

This is straight out of Visa’s rulebook: “Merchants cannot refuse to complete a purchase transaction because a cardholder refuses to provide ID.”

“Visa believes merchants should not ask for ID as part of their regular card acceptance procedures. Laws in several states also make it illegal for merchants to write a cardholder’s personal information, such as an address or phone number, on a sales receipt.”

Now, this is where it gets controversial, because Visa doesn’t want merchants to check for ID, but cardholders may actually want to show ID to reduce the likelihood of fraud (the opposite is also true).

Of course, Visa is in the business of collecting interchange fees as much as possible, so they wouldn’t be too pleased if consumers were repeatedly denied if they didn’t happen to have ID, though they can spin the policy as a measure to protect the identity of cardholders.

Merchants, however, must look at the back of the credit card to compare the signature with the one on the receipt, that is, if a signature is required for the purchase.

These days, it seems more and more purchases require less and less, as most merchants allow you to swipe a credit card on your own without it ever leaving your hands, which can obviously be good and bad for the consumer.

At the same time, incidental purchases no longer require a signature at many establishments, though policy certainly varies from merchant to merchant.

If you present an unsigned credit card to a merchant, they do have the right and should ask for identification before completing the transaction.

Some cardholders seem to think they are protecting themselves from identity theft by not signing the back of a credit card, but in actuality, how often do merchants really verify the signature anyways?

And if you fail to sign your credit card, it may result in a declined transaction, which could be more hassle in the real world than the risk associated with identity theft.

Personally, I don’t mind if merchants ask to see my ID, but some consumers are aware of the rules and adamantly deny requests for ID, which usually results in nothing more than arguments.

Bank of America Raising Interest Rates on Credit Cards with Balances

Bank of America has become the latest credit card issuer to impose higher interest rates on customers who opt to carry a balance.

Beginning in June, account statements will reflect the higher rate, which will generally rise from the single-digits to the teens, the Wall Street Journal reported.

One example they cited pushed a cardholder’s interest rate up to 13% from 7.9%; the customer has decided to opt out, so her $2,000 loan balance will retain the old interest rate.

However, she’s unable to make new purchases using the credit card, as it would push the 13% rate on both new and old balances.

Some cardholders may not be so lucky, and could be forced to either accept the new terms or close the card and pay the remaining balance in full.

Bank of America said it began notifying customers of the changes last week, and said affected accounts had an average APR of 8.5%.

While it’s unclear the exact number of affected cardholders, the changes should impact roughly 10% of the bank’s credit card customers in the United States, so potentially four million credit cards.

If you’ve received a similar notice from Bank of America or another card issuer, it may be wise to shop around for a better deal, though there are no assurances these days if you’ll get approved or if the new card issuer won’t eventually jack up your “fixed” rate too.

Of course, that shady practice looks like it will change if the so-called Credit Cardholders’ Bill of Rights goes into effect next summer.

Recently, Chase raised minimum payment requirements on credit cards to 5% of the balance from 2% for certain customers, forcing many to come up with a lot more money each month.

Most of the cardholders affected by such changes tend to carry large balances for a long period of time without making any significant effort to pay them down.