Investment Glossary – Minimum Credit Card Payment
“Hmm, my cash flow looks a little tight, I wonder what the smallest amount I can pay off on my credit card is this month?”
Those aren’t encouraging words to read. But they do tend to happen more than we’d like to admit. Every credit card I’ve seen to this point in my life has a minimum payment required if you have an outstanding balance. That number is the amount of money you are required to pay in order to keep your line of credit in good standing and avoid delinquency, which can negatively affect your credit score and also put your credit line at risk if it continues for an extended period of time. Eventually, if you don’t pay people back, they decide they don’t want to lend you money anymore. Banks and other lenders aren’t any different.
Minimum credit card payments can vary based on the issuer and the card. There are several ways in which an issuer typically calculates your minimum payment:
- A fixed percentage of your outstanding balance – In this case, an issuer may require you to pay a changing percentage based on how much you have outstanding on your card. So if you have a $1,000 balance and your issuer requires you to pay back a minimum of 1% of the outstanding balance, you would owe at least $10 for the month. If the minimum payment requirement was 2%, you would have to pay at least $20 for the month.
- A fixed dollar amount, regardless of outstanding balance – Here, a lender decides that rather than paying a changing dollar amount every month that you have an outstanding balance, you instead owe the same amount every month, regardless of the balance. So for an issuer with a $25 minimum payment requirement, you would have to pay $25 per month, regardless of whether you had $1,000 or $10,000 in outstanding charges on your card.
- The outstanding interest on your balance – This is where the math starts to get a little trickier. In some cases, an issuer will require you to pay at least the credit card interest accrued for the month on your outstanding balance. Let’s keep the math as simple as possible and say that you have a $1,000 balance that charges interest at 12% per year. In a 30-day month, this means that you would owe $9.86 in interest charges (12% times 30 days, divided by 365 days, times $1,000). So if the issuer required you to pay just the outstanding interest, you would have to pay $9.86 for the month.
- A combination of the above three calculations – Many issuers use a combination of these numbers to ensure a higher minimum payback each month. One hypothetical combination could be a percentage plus the outstanding interest – so one percent of your outstanding balance plus the interest charged. Another could be a fixed dollar amount or a fixed percentage, whichever is higher – so the higher of two percent of your outstanding balance or $25.
Paying the minimum balance on your credit card is effectively how you keep that line of credit open by staying in good standing with your lender. Generally, you want to pay significantly more toward your outstanding balance each month, but if you find yourself in a tight situation because of unexpected costs or just bad spending habits that built up over time, be sure to avoid abandoning payments altogether. This can affect your credit score and your ability to keep your credit line open in the future. Minimum payments are kind of like showing up to work – they represent the base level you need to maintain in order to not run into problems. But simply paying the minimum required payment on your credit cards every month is a recipe for ending up with a lot of interest charges over a long period of time, so always seek to pay off that balance as soon as possible.