# Financial Literacy

Making the Minimum Payment is a Bad Choice

# Making the Minimum Payment is a Bad Choice

Clive’s minimum payment is based on his balance and interest rate. Credit card companies typically require a monthly payment of at least 2%-4% of the card balance. Clive Clueless’ is “interest plus 1%)…

Annual rate - 23%
divided by 12 months (12)
= monthly rate - 1.9%

Balance - \$3,200.00
Monthly rate + 1% - 2.92%
Minimum payment = \$93.33

If he pays the minimum payment of \$93 a month…

• It will take him 239 months (20 years) to pay off his balance.
• He’ll have paid almost \$5,500 in interest to borrow that original three grand!

http://www.bankrate.com/calculators/managing-debt/minimum-payment-calculator.aspx

Part of the reason that it would take so long is that when Clive Clueless makes his \$93 payment each month, most of his payment goes to paying interest. Only what’s left over after interest is paid goes toward his principal. The principal is the balance on a loan; the actual dollars Clive Clueless spent using his credit card that he has to pay interest on.

FYI: Approximately half of all credit card holders don’t pay the full amount of credit card charges each month.

How a Minimum Payment is Applied

 How a Minimum Payment is Applied Beginning Balance \$3,200 Payment Amount \$93 Amount applied to interest \$61 Amount applied to principal \$32 Ending balance \$3,168

Clive Clueless has another option: make larger payments for a while. That way he won’t have to pay as much interest because he’ll be paying down the principal faster.

Clive decides the best alternative is to work extra hours and make the \$300 payment. Hands down, making the \$300 payment versus the minimum payment is the best option. He’ll pay \$5,000 less in interest and it’ll only take 13 months rather than 20 years.

 Pay-off Options Pay it all off ASAP Make large payments Make minimum payments Beginning credit card balance \$3,200 Payment amount \$1,100 \$300 \$93 Number of payments 3 13 239 Balance after 3 months \$0 \$2,470 \$3,105 Interest paid so far \$124 \$170 \$182 Balance after a year \$14 \$2,836 Interest paid so far \$414 \$697 Balance after 5 years \$1,751 Interest paid so far \$2,777 Balance after 20 years \$0 Interest paid so far \$5,479