When it comes to credit card balances, the best option is to pay it off in full and on time but the reality is one, it’s not always feasible and two, even if we can afford to do more, some of us are choosing not to.
When you’re stuck in a debt cycle, it’s tempting to continue doing the bare minimum (I was guilty of this for a long time) but the truth is minimum payments are keeping you in debt and might be doing more harm to your finances than good.
Financial experts always say if you can’t pay off your balance in full, it’s imperative you at least make the minimum monthly payment — this is the lowest amount you have to pay each month on your balance to remain in good standing with your credit card company.
According to the Financial Consumer Agency of Canada(FCAC), it’s either “a flat dollar amount, usually $10, plus any interest and fees or the higher of a dollar amount, typically $10, or a percentage of your outstanding balance, typically 3%.”
Here’s what you need to consider when only making the minimum payment on your credit card balance:
It will take you longer to pay off your debt
“People continue to resort to credit card debt and paying the minimum payments puts you at risk in so many different ways,” said Jackie Porter, a certified financial planner, in a phone interview.
Porter explained how the minimum payment trap is designed to keep you enslaved to lenders for a long time because minimum payments will first pay interest, then pay the fees and last put a small amount into the principle, meaning you're barely making a dent on your balance.
In an effort to urge people to make better credit decisions, Ontario requires banks and other federally regulated financial institutions to show an estimate on your credit card statement of how long it will take you to pay your balance if you make only the minimum payments.
In August 2019, Quebec went a step further and now requires residents to pay at least 2% of the outstanding balance.
But if you don’t read your statements closely, you’re still at risk.
Tracey Bissett, chief financial fitness trainer at Bissett Financial Fitness Inc., suggested you use a credit card payment calculator to see exactly how long it would take you to pay off debt if you only make the minimum payment each month because increasing your monthly payment by even a small amount will shorten the time it will take you to pay off your balance by a lot.
If you don’t pay your entire credit card balance by the due date, you’ll pay interest. A huge problem is that credit card debt typically has a higher interest rate than lines of credit or student loans.
So making the minimum payments and letting the interest pile up, does little to nothing to pay down your balance and results in paying double or triple the original borrowed amount.
Investopedia shows, for example, “if you had a $5,000 balance on a card with an 18.9% interest rate and your minimum payment was $200 each month, it would take you 11 years and five months to pay the entire balance. By the time you make the last payment, you will have paid $8,109.”
That’s $3,109 extra that could be used for something else.
Negatively affecting your credit history
Many factors decide your credit score, but a good chunk of it relies on your payment history.
If you show lenders that you are a responsible borrower you're more likely to get access to better financing.
While having “a long history of making your payments on time,” can be seen by most lenders as a good sign when making credit decisions, if you're only making minimum payments a lender can look at your credit report and score and choose not to lend you money or charge you higher interest rates.
I often use examples with clients that if I lend you $100 and it takes you three years to pay me back and you come back to me asking for more money. What are the odds I'm going to loan you more money? Porter said.
All things considered, if you can’t afford more than the minimum, what can you do?
“Sometimes your situation could dictate that you do need to carry a balance for a while,” Bissett said. In that case, Bisset suggested you move to a lower rate card (from 19% to one under 10%, for example).
In terms of other credit options, Porter suggested you take advantage of the best balance transfer credit cards — “the extra money you’re saving on interest can be put towards your balance.”
It’s important to reiterate that making the minimum payment is still strongly encouraged because missing payments can severely impact your overall financial health.
But be mindful that minimum payments aren’t enough to make progress and not making progress on your debt can be extremely frustrating and it can “take a toll on your mental health,” Porter said.
“If you're only making the minimum payment on your credit card, that's not going to be helpful to you to accomplish milestones in your life,” Bissett added.
“Whether your goal is to buy a car, get a house, go on to further school, you may not be able to secure the financing you need to go and pay for that thing that you want to do.”