What is a Minimum Payment
A minimum payment is the smallest amount of a credit card bill that a credit card holder must pay each billing cycle to avoid paying penalties. The minimum payment is usually based on one of three things: 1) a flat minimum dollar amount, such as $35, 2) a small percentage of the new balance, such as 2 percent, or 3) the interest charges and late fee plus a flat dollar amount, such as $20. However, if the statement balance is smaller than the lowest of these calculations, for example if the balance is $12, then the minimum payment will be the same as the balance.
BREAKING DOWN Minimum Payment
The minimum payment is important because it affects how the credit card payments are applied to the balance. Any payment a cardholder sends in will usually be applied to their minimum payment first, and then to either balances with higher annual percentage rates (APRs) first or to balances with lower APRs first. It depends on the terms that the cardholder agreed to when they first applied for the card, which can also be found in the card’s terms and conditions.
It is important for a cardholder to read the credit card’s terms and conditions, sometimes called the cardmember agreement, cardholder agreement or something similar, to see how the card issuer calculates the minimum payment for the card. A cardholder is not required to pay more than the minimum payment, but any portion of the balance that is unpaid will accrue interest unless they have qualified for a zero-percent APR offer. Also, if a cardholder doesn’t make the minimum payment by the due date, they will usually be charged a late fee.
Why Not to Pay Only the Minimum Payment
Making only the minimum payment on a credit card is a good way to stay in debt long term and spend lots of money on interest. For example, if a credit card balance is $5,000, the interest rate is 18 percent, and the minimum payment is $100, making only the minimum payment means it will take 472 months, or more than 39 years, to pay off the balance. What’s more, that cardholder will pay almost $14,000 in interest. However, if that cardholder commits to putting $500 a month toward their $5,000 balance, they will pay it off in just 11 months and spend about $460 on interest. The best options, of course, are to pay the balance in full and on time each month or to not use a credit card at all and avoid going into debt altogether.