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.

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.

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.

[Check out my Credit Card Debt Calculator to keep tabs on all your outstanding credit card balances.]

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?

By Colin Robertson

Colin created this blog after spending several years in a job that required him to scour credit reports on a daily basis. His goal is to help individuals better understand their credit and get the most out of credit cards.

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