It's like running on a financial treadmill. Anybody with a credit card balance knows that making only the minimum payments takes a lot of your money but gets you nowhere. 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.
To make it even more depressing, let's say that you purchased a beautiful bedroom suite for $5,000. Once you pay the credit card balance making only the minimum payments, you will have paid 62% more for that bedroom suite while watching the value of your furniture drop with each passing year. Will you still own that furniture 11 years from now? Why does it work out to be so customer unfriendly? It's because the credit card companies employ some tricks to keep you paying more.

SEE: How Credit Card Delinquency Works

According to Bankrate.com, your minimum payment is calculated as a percentage of your total balance. This includes the interest that is added to the balance each month. In our example above, the minimum payment of $200 is based on the credit card company requiring no less than 4% of your daily balance each month. Basing it on a percentage instead of a fixed amount works in the credit card company's favor because you keep a higher balance allowing the credit card company to charge more interest. Once you pay your balance down to $2,500, your payment is now only $100. When you reach $1,000, you're only required to pay $40. What if credit cards worked like mortgages and you paid a set amount regardless of your balance? If you were to pay $200 per month until the balance was paid, it would take you 32 months instead of 137 months and you would pay nearly 50% less in total interest.

Lower Percentage
Four percent of the balance is steep, and likely too much for some people, which is why many card companies only require 2%. If you only pay 2% each month, it will take you more than 30 years to pay off the balance and you'll end up paying more than $19,000 in total payments. That makes your $5,000 bedroom suite 280% more expensive. If there was a price tag of $19,000 on the furniture, would you still have bought it?

The Best Strategy
Of course, the best strategy is to pay as much as possible in the shortest amount of time. If you have money in an investment account that isn't retirement related, pay off your credit cards before investing. Next, if you're only able to pay the minimum amount right now, continue paying the same amount as your balance decreases. Finally, if you have multiple credit cards, make minimum payments on all cards except for the card with the highest interest rate. Pay the maximum possible on that card until it's paid off. Then, go to the card with the next highest interest rate and add the amount you were paying on the last card to the current card. This will allow you to pay a higher amount on each card as one is paid off. To make it even more simple, don't decrease your total monthly credit card payment until all of your cards are paid off.

SEE: Worst Case Scenario For Credit Card Debt

The Bottom Line
Paying the minimum balance might keep your credit report in good shape, but it will do little to help pay down the balance on your credit card. Paying hundreds or thousands per year in interest is a financial emergency that you should remedy quickly. Giving up some of your non-essential spending in order to pay off the debt is the best investment you can make.

Related Articles
  1. Savings

    How Volatile Exchange Rates Affect Your Vacation

    Those ever-changing fluctuations can make a difference in anything from your hotel room to an ATM transaction.
  2. Credit & Loans

    Can Corporate Credit Cards Affect Your Credit?

    Corporate cards have a hidden downside. If the company fails to pay its bills, you could be liable for the amount and end up with a damaged credit rating.
  3. Investing News

    What Is The New Credit Card Chip Good For?

    Under current U.S. credit card requirements, credit card issuers are required to issue chip cards as of October 1, 2015. Instead of swiping your card as you do now, you will slide the card into ...
  4. Credit & Loans

    5 Ways to Maximize Your Credit Card Points

    How to get the most bang for your rewards buck.
  5. Investing

    How to Effectively Compare Credit Card Rewards

    There are so many different reward credit cards that are available. Understanding how each type work will help you pick the best card for your needs.
  6. Credit & Loans

    Joint Credit Cards: The Pros and Cons

    A joint credit card may sound like an easy way to split the bills, but make sure you know what you’re getting into first.
  7. Credit & Loans

    Travel Tips: Avoid Exchange Rate Headaches

    How to avoid the most common issues and hassles raised by exchange rates while traveling abroad.
  8. Investing

    Why U.S. Credit Cards Are Getting a Chip and Pin

    With the introduction of EMV technology into U.S. credit cards, consumers should worry less about fraud and counterfeiting.
  9. Credit & Loans

    What Qualifies as a Nonperforming Asset?

    A nonperforming asset is a loan made by a financial institution to a borrower who has failed to make any scheduled payments for at least 90 days.
  10. Personal Finance

    Best Ways to Exchange Currency

    How to avoid fees and get the best deal for your dollar.
RELATED TERMS
  1. Transferable Points Programs

    With transferable points programs, customers earn points by using ...
  2. Luhn Algorithm

    An algorithm used to validate a credit card number.
  3. Roll Rate

    The percentage of credit card users who become increasingly delinquent ...
  4. Truncation

    The requirement mandated by the FTC for merchants to shorten ...
  5. Purchase Money Security Interest ...

    A security interest or claim on property that enables a lender ...
  6. Linked Transfer Account

    Accounts held by an individual at a financial institution that ...
RELATED FAQS
  1. What is the difference between "closed end credit" and a "line of credit?"

    Depending on the need, an individual or business may take out a form of credit that is either open- or closed-ended. While ... Read Full Answer >>
  2. What is the best way to start to rebuild your credit after a bankruptcy?

    Bankruptcies can be devastating to your credit score. Even worse, a bankruptcy will be listed on your credit report for between ... Read Full Answer >>
  3. What are typical forms of long-term debt for a public company?

    Public companies fund their operational needs and capital expenditures with equity or debt. Most often, companies choose ... Read Full Answer >>
  4. What is the difference between subordinated debt and senior debt?

    The difference between subordinated debt and senior debt is the priority in which the debt claims are paid by a firm in bankruptcy ... Read Full Answer >>
  5. What were the primary financial crimes involved in the ZZZZ Best case?

    ZZZZ Best was a company started by Barry Jay Minkow that claimed to be a carpet cleaning business. In fact, it was a Ponzi ... Read Full Answer >>
  6. Can a creditor sue me for a delinquent account?

    If a credit card account becomes delinquent, the creditor can sue the debtor for the balance as soon as the delinquency occurs. ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!