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!
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|
|Amount applied to interest||$61|
|Amount applied to principal||$32|
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 it all off ASAP||Make large payments||Make minimum payments|
|Beginning credit card balance||$3,200|
|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|